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A PRIMER ON MONEY
COMMITTEE ON BANKING AND CURRENCY HOUSE OF REPRESENTATIVES
WRIGHT PATMAN Chairman 1964
The truth is, however, that the Private banks, collectively, have deposited not a penny of their own funds, or their depositors funds, with the Federal Reserve banks. The impression that they do so arises from the fact that reserves, once created, can be, and are, transferred back and forth from one bank to another, as one bank gains deposits and another loses deposits. [pg 37]
The writer [Wright Patman] has had a couple of personal experiences which 'have provided some amusing confirmation of the fact that the source of bank reserves is not deposits of cash by the member banks with the Federal Reserve banks....
Since I had also seen reports that the member banks of the Federal Reserve System had a certain number of millions of dollars in "cash reserves" on deposit with the Federal Reserve bank, I then asked if I might be allowed to see these cash reserves. This time my question was met with some looks of surprise; the bank officials then patiently explained to me that there were no cash reserves. The cash, in truth, does not exist and never has existed. [pg 38]
The Federal Open Market Committee.
There are 19 participants in this powerful body, 7 appointed by the President of the United States and confirmed by the Senate of the United States. Once appointed, however, a man serves for a period of 14 years, and cannot be removed by the President or by any other official body, except for cause. The other 12 men in this select group are elected to their places through the votes of private commercial bankers. there are 12 voting members of the Federal Open Market Committee. The voting members consist of 7 members of the Board of Governors of the Federal Reserve System, plus some 5 of the 12 Federal Reserve bank residents. [pg 65]
Because of this, the balance of power over the money supply lay securely, it was thought, with the public side of the System through authority of the Board of Governors. But when the move toward the alternative open-market technique of control was given legislative blessing by Congress in 1933 and 1935 and a full-fledged central bank thereby created the balance shifted radically toward the private, commercial banking side of the System. [pg 72]
[COMPLETE REMOVAL OF GOVERNMENT CHECK ON BANKS]
......In mid-August of 1950, however, the Federal Reserve raised the discount rate and short-term Treasury bills jumped toward 11/2 percent, although there were requests from the Secretary of the Treasury and the President for the System to continue a low-rate policy. It was later revealed by testimony of some of the Federal Reserve officials to committees of Congress that the Open Market Committee had held a meeting on August 18 and decided not only t o raise the discount rate, but to "go their own way" on the Government longer term bond rate as well, despite what the President, the Secretary of the Treasury, and the head of the Office of Defense Mobilization might do....
Since the signing of the so-called accord, in March of 1951, this event has been widely interpreted as an understanding, reached between the Treasury and the Federal Reserve, that the Federal Reserve would henceforth be "independent." It would no longer " peg Government bond prices. It would raise or lower interest rates as it might see fit, as a means of trying to prevent inflation or deflation. These are understandings which have been grafted onto the accord over the years. Certainly, no such understandings were universal at the time the accord was signed. ....
At the end of 1951, then, the Federal Reserve had both self-proclaimed independence, as a result of the accord, and an operational policy which aimed at maximum credit effects through minimum changes in interest rates..... the Federal Reserve people were quite sure that they could do a better job of running the country than the President, and with only slight increases in interest rates. ...
It then added another string to its bow- the “bills only" policy. ... Henceforth when the Treasury issued bonds or medium-term securities, it was to dump these issues on the market and watch the natural consequences-first a drop in bond prices, then a gradual recovery as the market absorbed the bonds. Any private rigging or manipulations of the market were to go without interference from the Federal Reserve, as were any speculative booms or panics short of a "disorderly" market. The “bil1s-only” policy had only one reservation: The Federal Reserve would buy long-term bonds in the event that the Open Market Committee made a findings that the market was disorderly. [ full details starting on pg 103]
The [Eisenhower ] administration announced at the outset that it would re1y on monetary policy exclusive1y for its economic regulation and would respect the complete independence of the Federal Reserve to carry out these policies as it saw fit .....
Thirteen years have now passed since the accord and the liberation of the Federal Reserve. What have been the results? The major result is shockingly obvious. Interest rates have climbed steadily, with slight interruptions, during the entire post accord period. (See table 3.) The period has been marked, then, by a continual shift of income to the banks, other major financial institutions, and individuals with significant interest income. The rest of the country provided this income........
Another result of post accord monetary policy is that the U.S. economy has unwittingly become a low investment economy... The Federal Reserve has chosen the high interest, slower growth option for this country.
Although the money in the Federal Reserve is not in anyway “owned” by private banks they get paid interest on it.... “In its latest power play, on October 3, 2008, the Fed acquired the ability to pay interest to its member banks on the reserves the banks maintain at the Fed. www.globalresearch.ca...
Why was the Federal Reserve Act written to require member banks to invest in the so-called stock of the Federal Reserve banks? The framers of the Federal Reserve Act gave many reasons, but the main, reason was this: it was expected that the Federal Reserve would issue money, not mainly against Government securities as is now the practice, but against commercial and industrial loan paper-"eligible paper" as the reader knows.
It was in view of these considerations that Congress, in framing the Federal Reserve Act in 1913, required member banks of the Federal Reserve System to put a certain percentage of their capital into the .'stock" of the Federal Reserve banks; this "stock" was a safeguard against a misuse of the Government's credit which was being delegated to these banks. The 1913 act placed on the member banks, furthermore, a "double liability" for their "stock" in the Federal Reserve banks. In other words, if a Federal Reserve bank failed, the member banks would lose not only their invested capital, but an equal amount of capital which they would also forfeit. [pg 79]
The 1933 act also prohibited commercial banks from making stock market loans, and investment banks from accepting public deposits. This was an effort to prevent a wave of stock market speculation like that of the twenties by keeping commercial banking and investment banking separate and distinct. [pg 84]
What changes were made the Banking Act of 1935?
The Federal Deposit Insurance Corporation
was made permanent, and the Board of Governors was given power to change reserve requirements. The act of 1935 had other important revisions :
(1)The Board of Governors of the Federal Reserve System was changed. Membership no longer included the Secretary of the Treasury and the Comptroller of the Currency, and the number of members was cut from nine to seven. The name, the Federal Reserve Board, was changed to the Board of Governors of the Federal Reserve System. The reorganized Board, with its increased powers really gave us a central bank for the first time, in place of a system of individual Federal Reserve banks which were largely on their own.
(2) Also of primary importance in creating a true central bank was the establishment of the Federal Open Market Committee to determine purchases and sales of Government securities for the entire System.
(3) Another change made by the 1935 act related to loans of the Federal Reserve banks. This act allowed the Federal Reserve banks to extend reserve bank credit on any type of credit which the commercial bank possessed.
4 ) The 1935 act also contained provisions concerning regulation of bank holding companies. [Pg 84]
Private banks enjoy a very special relationship with the Federal Government. After all, most business firms employ private capital or privately owned resources to produce a product or provide a service which can be profitably sold in the marketplace. Most business firms pay for the raw materials and services they receive, and, furthermore, in the case of most kinds of business firms, the business itself is a risk-taking venture. The firm succeeds or fails in competition with other business firms.
But the conditions under which private banks operate are very different. In the first place, one of the major functions of the private commercial banks is to create money. A large portion of bank profits come from the fact that the banks do create money. And, as we have pointed out, banks create money without cost to themselves, in the process of lending or investing in securities such a Government bonds. Bank profits come from interest on the money lent and invested, while the cost of creating money is negligible. (Banks do incur costs, of course, from bookkeeping to loan officers' salaries.) The power to create money has been delegated, or loaned, by Congress to the private banks for their free use. There is no charge.
On the contrary, this is but one of the many ways the Government subsidizes the private banking system and protects it from competition. The Government, through the Federal Reserve System, provides a huge subsidy through the free services the System provides for member banks. "Check clearing" is one of the services; i.e., the collection and payment of funds due one bank from another because of depositors' use of their checkbook money. The costs of this service alone runs into scores of millions of dollars.
The gross expenses of the combined Federal Reserve banks totaled $207 million in 1963, most of which was incurred as a cost of providing free services to the private banks. Other Federal agencies also receive services from the Federal Reserve. But these are not free. The System received about $20 million for "fiscal agency and other expenses" in 1963.
In addition, the Federal Government provides private banks with a large measure of protection from competition, and the hazards of failure. ... This means, in brief, that nobody can enter the banking business by opening a national bank, unless the proposed bank is to be located where it will not cause an inconvenient amount of competition to other banks already in business. [pg 89]
The 1980’s buyout boom
Historically, leveraged buyouts soared in the 1980s due to various U.S. economic and regulatory factors. First, the Reagan administration of the 1980s employed very liberal federal anti-trust and securities legislation, which greatly endorsed the merger and acquisition (M&A) of corporations. Second, in 1982, the Supreme Court declared any state law against takeovers as unconstitutional, further promoting corporate M&A. Third, deregulation (relaxation, reduction, or complete removal) of many industry-related legislation restrictions incited further proceedings of corporate reorganization and acquisition. In addition, the use of risky high-interest bonds (also known as junk bonds) made it possible for multi-million dollar companies to buyout enterprises with very little capital.
What is a leveraged buyout?
A leveraged buyout or LBO is a type of aggressive business practice whereby investors or a larger corporation utilizes borrowed funds (junk bonds, traditional bank loans, etc.) or debt to finance its acquisition. Both the assets of the acquiring corporation and acquired company function as a form of secured collateral in this type of business deal. Often times, a leveraged buyout does not involve much committed capital, as reflected by the high debt-to-equity ratio of the total purchase price (an average of 70% debt with 30% equity). In addition, any interest that accrues during the buyout will be compensated by the future cash flow of the acquired company. Other terms used synonymously with an LBO are “hostile takeover,” “highly-leveraged transaction,” and “bootstrap transaction.”
Once the control of a company is acquired, the firm is then made private for some time with the intent of going public again. During this “private period,” new owners (the buyout investors) are able to reorganize a company’s corporate structure with the objective of making a substantial profitable return. Some comprehensive changes include downsizing departments through layoffs or completely ridding unnecessary company divisions and sectors. Buyout investors can also sell the company as a whole or in different parts in order to achieve a high rate on returns.