Thursday, October 16, 2008

The beginning of 'unmanageable liabilities'.

Coincidence? That when banks adopted 'managed liabilities', using the huge pool of Eurodollars and soon afterward the petrodollars, we experienced historically-unprecedented prolonged inflation. The pool of surplus 'savings' should surely have reduced interest rates but instead banks became a major customer for surplus funds. Their behaviour, as such, would have artificially pushed up the cost of capital (ie interest rates). In themselves the resulting higher charge on debt would have surely created a major source of inflation on its own. Then monetary policy would have created a vicious spiral in further raising inflation (that at least partially resulted from higher interest rates) by raising interest rates further?

"[In the 1960s] American banking had discovered a more aggressive approach to management that evaded the traditional inhibitions of deposit growth, a method for achieving faster growth that appealed especially to the largest and most ambitious banks. Instead of waiting for new deposits the banks would go ahead and make new loans, then turn around and borrow huge sums themselves, in effect “buying” their deposit base in the money market to finance the expansion of credit. The practice was known as “managed liabilities,” since both the regular deposits and the borrowing done by a bank constitute the liabilities on its balance sheet – money owed to someone else. Conversely, a bank’s outstanding loans were its assets – the money it will collect from someone else (exactly the reverse of how families or businesses would describe their balance sheets). Managed liabilities depended on banks issuing such large financial instruments as certificates of deposits and Eurodollar borrowings of $100,000 and in much greater sums. As long as the banks could count on borrowing new funds at a lower interest rate than they charged for lending them out, the interest rate spread assured their profits. [25]”

[25] (William Greider’s] "brief description of how the management strategies of commercial banks evolved into a more aggressive competition is a capsule summary of a rich and complex story. The development is traced in fascinating detail in two books by Martin Mayer, ‘The Bankers’, Random House, 1974, and ‘The Money Bazaars’, EP Dutton, 1984. The international implications are lucidly explained by Michael Moffit, ‘The World’s Money’, Simon and Schuster, 1983."

From: ‘Secrets of the Temple – How the Federal Reserve runs the country’ by William Greider. Pages 109 and 110.
Touchstone Simon & Schuster Building, Rockefeller Center New York. ISBN 0-671-67556-7 pbk. 1987.

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