When Big Brother becomes bankers' Big Boss

A mainstream media outlet has finally reported openly what many of us have suspected for several years.  Banks are being 'encouraged' (read:  coerced, even forced) to buy sovereign debt (i.e. government bonds), thereby keeping their national states afloat.  CNBC reports:

US and European regulators are essentially forcing banks to buy up their own government's debt—a move that could end up making the debt crisis even worse, a Citigroup analysis says.

Regulators are allowing banks to escape counting their country's debt against capital requirements and loosening other rules to create a steady market for government bonds, the study says.

While that helps governments issue more and more debt, the strategy could ultimately explode if the governments are unable to make the bond payments, leaving the banks with billions of toxic debt, says Citigroup strategist Hans Lorenzen.

"Captive bank demand can buy time and can help keep domestic yields low," Lorenzen wrote in an analysis for clients. "However, the distortions that build up over time can sow the seeds of an even bigger crisis, if the time bought isn't used very prudently."

"Specifically," Lorenzen adds, "having banks loaded up with domestic sovereign debt will only increase the domestic fallout if the sovereign ultimately reneges on its obligations."

The banks, though, are caught in a "great repression" trap from which they cannot escape.

"When subjected to the mix of carrot and stick by policymakers...then everything else equal, we believe banks will keep buying," Lorenzen said.

There's more at the link.

If you think about it, the Federal Reserve has been buying up to 70% of US Treasury bonds, because foreign investment in them had largely dried up (until the current Euro crisis, which has driven some European investors to buy US treasuries out of sheer desperation, looking for the safest possible haven for their money).  The remaining 30% are rather neatly accounted for by this report.  When you're the authority regulating all other banks in the country, you have an awful lot of influence over them.  It would take a very courageous (or extraordinarily foolhardy) bank president or director to resist the 'suggestion' that it would be a good thing for his institution to buy a few billion dollars' worth of US Treasuries.

(Of course, if we're hit by a major economic crisis - which I believe is almost upon us - those banks will no longer have the 'cushion' of that capital available to help their depositors . . . it'll all be tied up in Treasuries.  Still, the Fed doesn't care about that.  It's trying to find as many fingers as it can, to stick them in the cracks in the fiscal dyke.  If some or all of them get chopped off eventually, well, that's just too bad - just as long as they're someone else's fingers, rather than the Fed's.  The European Central Bank and other national equivalents appear to be doing precisely the same thing.)

This is also why, if you have any financial reserves at all, you should be keeping a portion of them in cash, in a safe place.  It'll be available if the banks suddenly have no more to issue.  It's also why, if I had any investment income to spare (which unfortunately I don't), I'd be putting it into gold and hard assets right now - not into any account or piece of paper that someone else controls!  Until we know which way things are going to go, the risks are just too high for me to trust the financial 'powers that be' - after all, they're the very 'powers' that got us into this mess in the first place!

Peter