THE FED CHANGES THE RULES WHEN IT IS TRAPPED -> THE "MONEY MARKET SWEEP" EXAMPLE

MATASII: Chart Courtesy of Bill Bonner via InternationalMan.com,

You will note that global debt was only $30 trillion in 1994. Now it is $230 trillion. That $200 trillion in extra credit is probably the whirlwind that sent equities spinning up to the top right.  Those gusts blew stock and other asset prices up to heights never seen before. The Dow reached over 26,000. Houses went on the market for more than $100 million. Gold rose above $1,900.

Many things have contributed to this but it started with a change quietly made by the US Federal Reserve. Below Chris Martenson lays out what exactly happened in January 1994.

Something you will also notice in the chart above is that until the mid-’90s… and again between 2008 and 2012…

the average investor got essentially no benefit in exchange for the added risk of putting his money into equities (the chart above includes dividends). He might just as well have left his money in U.S. Treasury bonds.

In theory, he is supposed to be able to earn some return – over pure cash – by lending his money to the U.S. government (with the 10-year Treasury bond as the benchmark). He should be able to earn even more, a premium (more than he would earn from risk-free Treasurys), by investing in stocks. The premium is supposed to compensate him for the risk that his stocks could go down at an inconvenient time.

In practice, we find that risk-free Treasurys gave him less than nothing. He has earned less from Treasurys than he would have from gold (which pays zero interest) – over the entire 48-year period.

 

--FOLLOWING ANALYSIS EXCERPTED FROM: 02-03-18 Chris Martenson via PeakProsperity.com - "It's Looking A Lot Like 2008 Now..." --

The above chart shows the Fed’s 'REIGN OF ERROR'.  It began with the deeply unfortunate sweeps program initiated at the end of 1994 (described below), proceeded to the echo bubble that itself broke in 2008 with even greater damage done, and all of which has led us to where we are today.

Note the twin panics of 2016 on the above chart.

Panic #1 occurred when our current bubble threatened to burst -- that scared the living daylights out of the Big 3 central banks: the Fed, the ECB and the BoJ. So they colluded to juice the markets and boy, did they succeed.

Panic #2 was the surprise election of Donald Trump.  So much thin-air currency was created and dumped into the markets after that unpredicted event that we got that the markets have pretty much gone vertical ever since (note the protractor in the chart above).

 

When this current bubble pops, the one that I've repeatedly described as The Mother Of All Financial Bubbles, the ensuing damage will be many multiples of that caused by the bursting of the bubbles that preceded it.  That’s the nature of these things: you either take your lumps when you should, or you pay a far steeper price later on.

So far, we've done all we can to postpone any consequences as far into the future as possible. Someday, maybe someday very soon, those consequences will arrive. And, at our unprecedented extremes in (over)valuation, the price we will have to pay then will be very steep indeed.

"SWEPT AWAY"

One of Greenspan's biggest sins while at the helm of the Federal Reserve was allowing the banks to implement “sweep accounts” for retail deposit accounts.

Banks are required to hold some of your deposited money ‘”in reserve”, commonly around 10%, to act as a cushion against insolvency risk.  This means that if you have $1,000 on deposit at a bank, it's supposed to have $100 of that in cash on hand in case you unexpectedly walk in and demand some of your money back.

Since it’s only during a bank run that everybody wants 100% of their money back, the Federal Reserve only required banks to keep just 10% of depositor money on hand at any given time. The rest can be loaned out. (That's why this is called 'fractional reserve lending').

Banks don’t make very much money by holding onto your money.  They want to “put it to work".  Through the miracle of fractional reserve banking (at 10% in reserve) your deposited $1,000 can be turned into $9,000 of new loans.

Instead of offering you 0.5% on your savings while getting 1.5% on a Treasury bond (booooooring!) and pocketing the 1% spread, banks would prefer to lend out 90% of your deposit to a homeowner while charging 4% and pocketing a whopping 3.5% spread.

In Scenario A the banks make $10 from their 1% spread on $1,000. In Scenario B they make $355 in net interest profits on your same $1,000 deposit. That's a big difference.

But what if even that’s not enough to sate the banks' hunger for greater profit? What if the banks feel overly hamstrung by that pesky 10% reserve requirement?  What if they only had to hold 5% in reserve?

Well, then $20,000 in loans can be made against your $1,000 deposit.  If we call this Scenario C (again at a 4% loan rate,) then banks can make $755 in net interest profit on the back of your $1,000 deposit.  Now that’s more exciting!

But how to get around that pesky 10% reserve requirement?  This is where Alan Greenspan stepped in back in 1994. Facing unwanted tightness in the corporate bond market, an effort was made to inject more liquidity into the system. Greenspan's solution for where that new money should come from was to allow the extension of sweep accounts into retail banking.

Now, what's a sweep account? Good question.

If you have a checking account with a bank, you very likely also have a corresponding sweep account (also in your name) that you probably never knew was there.

Each night, right before the bank's reserve snapshot is taken, all of the money in your checking account is briefly "swept" into a special sweep account which has no reserve requirements. So, when the reserve snapshot is taken for your bank, presto!, there's no money in your checking account -- so, as far the regulators are concerned, your bank need not hold any money in reserve for that account.

And right after the reserve snapshot is taken, presto again!, your money is swept right back into your checking account.

Sounds crazy or, at least, illegal -- right? But it's real.

From the Federal Reserve itself we get this description of sweep accounts:

Since January 1994, hundreds of banks and other depository financial institutions have implemented automated computer programs that reduce their required reserves by analyzing customers' use of checkable deposits (demand deposits, ATS, NOW, and other checkable deposits) and "sweeping" such deposits into savings deposits (specifically, MMDA, or money market deposit accounts). Under the Federal Reserve's Regulation D, MMDA accounts are personal saving deposits and, hence, have a zero statutory reserve requirement.

(Source)

The result of this program effectively removed reserve requirements altogether, allowing a flood of new lending to proceed. Sure, that fixed the corporate bond market tightness; but it also gave rise to the massive stock bubble of the late 1990s (see the red arrow pointing upwards on the above chart).

So why focus so much on the creation of the sweep accounts program?

First: this was the original error that the Fed has been responding to ever since, just as a drunk driver responds to a skid by oversteering this way then that way with the skid, over-correcting too much each time.  If you want to understand today’s dilemmas you have to know this little bit of history.

Second: this was the beginning of theWe’ll just change the rules when it suits our needs regime that has now so utterly infected the regulatory apparatus of the US financial system. As a result, for all practical purposes, there really aren’t any iron-clad rules we can count on anymore.

The corollary to this is that creating a lot of easy money is fun and exciting for a while, but then make things far worse in the end.

Why is that?  Because you can't print prosperity.  Money printing only steals prosperity from the masses, and most especially, from future generations -- that’s all the central banks really ever can do.

But theft isn't a sustainable form of governance. The central banks reign of error(s) will continue and compound until we, the people, finally rise up and demand something different.

What will it take to create enough public outrage to trigger this? Well, how about another massive financial crisis, one that may make 2008 look tame in comparison?

Look, bubbles always burst. And there are very worrying signs that the current Mother Of All Financial Bubbles is ending right now.

What most has my attention are

  1. Spiking interest rates and
  2. Oil prices threatening to head above $70/bbl.

These are twin shocks that our

  • Extremely over-indebted and
  • Over-leveraged economic system

simply can't withstand for long before breaking down.