If you are new to this blog, you are invited to read first “The Largest Heist in History” which was accepted as evidence and published by the British Parliament, House of Commons, Treasury Committee.

"It is typically characterised by strong, compelling, logic. I loosely use the term 'pyramid selling' to describe the activities of the City but you explain in crystal clear terms why this is so." commented Dr Vincent Cable MP to the author.

This blog demonstrates that:

- the financial system was turned into a pyramid scheme in a technical, legal sense (not just proverbial);

- the current crisis was easily predictable (without any benefit of hindsight) by any competent financier, i.e. with rudimentary knowledge of mathematics, hence avoidable.

It is up to readers to draw their own conclusions. Whether this crisis is a result of a conspiracy to defraud taxpayers, or a massive negligence, or it is just a misfortune, or maybe a Swedish count, Axel Oxenstierna, was right when he said to his son in the 17th century: "Do you not know, my son, with how little wisdom the world is governed?".

Thursday, 30 September 2010

The financial system, as we know it, is dead

Politicians, economists, bankers and mainstream media financial pundits fail to acknowledge the obvious: the financial system as we have known it for a hundred years or so is dead. Literally.

Until 2008 in the financial system a central bank was at its heart in every country (or a currency region like eurozone). It was regulating the money creation process by creating a lending base upon which commercial banks created credit. In a nutshell if economy had been getting overheated, i.e. there was an oversupply of money, sometimes called a "cheap credit", and inflation increased above what was regarded as an acceptable target (usually pretty low, in single percentage figures), the central bank would have raised the interest rate making borrowing more expensive. On the other side if inflation was too low, or growth too stagnant, the central bank would have lowered the interest rate thereby lowering the costs of borrowing. The interest rate had to be above an inflation rate as otherwise lending would not have made commercial sense. This is an obvious wisdom. What is somewhat less obvious is why it was so? Why if a central bank had raised or slashed interest rate, until the outbreak of the current financial crisis, all commercial banks would have had to follow? By no means this was regulated by any directives or government pressure. These were open market operations that worked until September 2008.

A central bank has a sole prerogative of printing money (whether as banknotes or through electronic credit, but this is the same). When a central bank set its interest rate it meant that it was prepared to lend to the financial markets at that rate. It would have also borrowed from the commercial markets below that rate. This was done using financial instruments bought and sold on the financial markets and priced by the financial markets. I.e. the price was real as other commercial institutions were selling and buying the same instruments at the same price. It is called open markets operations. A central bank was buying the financial instruments if they were giving more yield than its interest rate and selling them otherwise. This was producing the balance of money supply with inflation and growth as the commercial banks were lending at the rate that followed very closely the central bank’s own rate. For any commercial bank the central bank was, in practice, unlimited source of credit supply at the cost of its rate. The difference between a commercial interest rate and a central bank’s interest rate represented operating costs of a commercial bank and a customer risk (i.e. were insurance against bad loans).The existence of a number of commercial banks created competition market so their interest rates followed very closely central bank’s rate. The government did not have to tell the banks to lend money. After all it was their core business. Instead a central bank was raising or lowering its interest rate, did open market operations and the financial markets did the rest. All recessions as we knew them until 2008 were in fact market readjustments, balancing acts, between inflation, growth and money supply.

This does not work anymore. The central banks’ interest rates in the countries that suffered from the financial meltdown of 2008 (US, UK, Eurozone) are at the rock bottom. Below the inflation rates. The commercial banks are scarcely offering credit, well above the central banks’ interest rates. In fact they do not want to offer it at all and the governments are pathetically calling for the banks to start lending. (Well, they would if they could. It is their core business after all.) What’s happened? Why, as before and for a hundred years, central banks cannot intervene through open markets operations and let the financial markets sort that out?

The current financial crisis was caused by the financial institutions, with help from the regulators and the governments, setting up the giant global pyramid scheme by lending with loan to deposit ratio greater than 100%. The banks’ cash reserves were depleted and the money multiplier reached stratospheric levels. In fact no one knows it if risks of contingent and possible liabilities parked in OTC contracts and the shadow banking system are taken into account: the lowest estimates are around 50. Therefore a huge number of financial instruments on the financial markets do not represent much commercial value but the scale and depth of the pyramid scheme. Commercial buyers do not want to buy them. These instruments are worthless. Hence central banks cannot buy them either for newly printed money. Almost any additional liquidity is produced through quantitative easing. This is a centrally controlled process of spending newly printed (or electronically transferred) money on financial instruments for which there are no commercial buyers. This is in sharp contrast to how it used to be: the process of money supply was controlled by central banks and dynamically executed by the financial markets.

This crisis shows that financial system, with all its mechanisms like mark-to-market, worked till 2008. But it was simply killed when it was turned into a giant pyramid scheme. Little surprise there. The current governments’ actions of pouring taxpayers money (through quantitative easing, financial stimuli and spending cuts) are nothing more than pathetic attempts to revive rotting and smelly corpse of the pyramid scheme. Instead this pyramid must be liquidated and the system must be started afresh. There will be losers of course. The current political and financial establishments are trying to push the costs on the taxpayers. Taxpayers sometimes protest that they do not want to pay for the damage caused by the political and financial establishment (who still reward themselves very handsomely for the mess that they caused). It is still not clear who, in practice, will win this argument as the problem simply appears to be too big to be quietly absorbed by the taxpayers in an ordinary course of politics (taxes, spending cuts and government and businesses propaganda). Or, as the signs are, we might end up in an even bigger mess.


  1. It seems intended that your latest post follows the recent Irish revelations as to the yet more debts hidden in the Irish Banks, are you expecting similar revelations to surface from the UK? I do!

    Keep telling it as it is!

  2. I wrote this post before I have heard about the Irish developments today. These are nothing new, something to be expected in any country that participated in the pyramid (e.g. US, UK, eurozone). The pyramid is collapsing: it can be compared to a house being disintegrated by gradual subsidence. Hence to predict the exact timing and location is another matter...



  3. A Government's set of responsibilities differs from a commercial enterprise. Governments endure over a long period of time, they should be outside (some) market forces. Their chief aim is to achieve value for money e.g provide a great service to people for a reasonable cost. Bearing in mind that the goverment recoups a lot of what it spends e.g VAT, income tax, corp tax etc. Its aim is to recycle cash through the economy wisely by spending it on services and products that benefit the many and not the few. The end result is not greater profits but a better quality of life for its citizens.

    This is not to say that financially irresponsiblility shouldn't be punished (e.g bond markets in Europe currently) or that they should not be looking to profit from deals through understanding the market (e.g if you say you're going to sell £16bn of London Real Estate within the next few years prices will go down!! That's how supply and demand works...if the market knows you HAVE to get rid of something it devalues it! - same goes for our Gold reserves!).

    So, what we need is a Government who understands business and the markets and how to best play them but also that their end goals should be measured on value to its tax payer base. How do you measure this? Well you rank the problems facing society and you decide which ones you focus on (you don't tell the market!) and then you embark on improving the services to match the problems. For instance, improve waiting lists and self diagnosis for cancer or cervical smearing or implementing a sovereign wealth fund to pay for civil servants pensions in the long term through North Sea gas taxes.

    We're all tired of banks playing the un-even game where the government must disclose everything and be transparent but somehow they are commercial organisations which keep secrets. We should split investment and retail banking and realise that people should not get larger returns for money they need to live on. You speculate with cash you can afford to lose (or you should anyway) without changing you're lifestyle. This should apply to retail banks and funds too...

    Based on this assessment of government, what's the end game here? We clearly can't re-balance the trade deficits overnight? We can't re-train two decades worth of consumers to be producers easily. We can't shut down capitalism so when you say purge the system what do you mean? Who will it affect and how can it be realistically implemented without causing food riots and anarchy?

    p.s Greg I find your comments/articles exceptionally insightful..thanks for the blog!

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  5. Hi Rohit

    Thanks for reading my blog, your comments (and a good word). We should remember that it is the government that is in power not the bankers. If they do not prosecute fraudsters that organised the pyramid scheme that caused this crisis it is the government we should blame and ultimately us as we elect them. We live in a democracy: how many of us wrote to or visited our MP's that we elected and told them what we want?

    Where does it all lead to? I am not a fortune teller. I simply analyse mechanism and draw conclusions. The crisis that started with the market crash in 1929 finished 10 years later with the World War Two. The current crisis is not any smaller. Hence we can "look forward" to major re-alignment of world interest and influence. Its form, shape and timing is impossible to guess for me. But I do not expect it to be a nice event.



  6. A decent article slightly let down by the syntax. Your previous articles are a little slicker in terms of grammar and spelling.

  7. Hi Mark

    Thanks. The article was written (on the train) with the emphasis on explaining the mechanism rather than syntax correctness. (Running this blog is not my job and I put only my spare time: not in abundance.) Nevertheless if you send me a corrected version I will greatly appreciate it and put it on the blog (with thanks to you).




    Foreclosures via DECEPTIVE and FRAUDULENT PROCEEDINGS enables repetitive, and illegal property flipping; it enables lenders to falsify IRS form 1099-A’'s; it enables unscrupulous foreclosure mill lawyers (especially because of judges who purposefully abet deceit) to deceptively hold auctions and make insider bids to acquire those properties; and blighted neighborhoods. Fraudulent foreclosures ensure the success of FABRICATED BANKRUPTCY COURT 'Lift Stay motions' and false 'Proof of Claims'.

    Two particular companies that benefit from fraudulent foreclosures are Wells Fargo and Freddie Mac. Representations about Freddie Mac’s billion dollar losses should be weighed against the needless money Freddie Mac –as well as other lenders– PAY to foreclosure mills and debt collectors who utilize court systems to outmaneuver and persecute property owners who oppose unlawful foreclosures and repossessions. Further, when property owners file justifiably lawsuits for fraud and for OUTRAGEOUS “Unfair Debt Collection Practices,” against lenders and foreclosure mills, those same mill lawyers get to make even more $$$$ from those lawsuits as they litigate and cover up their own wrongdoings.

    Foreclosure fraud causes illegitimate homelessness and underhanded evictions, unjustified IRS tax bills due to false 1099-A's, and unfair "Deficiency Judgments." Ironically, some people who express their anger at "deadbeats" appear to be more acceptable about the manifest fraud and criminal activity being carried out by people with credentials to practice law. Equally ironic is the reality that some people pretending to be annoyed about "deadbeats"are the actual people who are participating in real estate racketeering -fully sanctioned by the majority of courts, especially Bankruptcy Courts! *more @

  9. Greg, I am new to your blog and like your articles. I’ll follow them from now one. Just one criticism: you have plenty of valid criticisms of the banking system, but you don’t seem to spell out in much detail what the alternative is.

    I suggest the alternative follows logically and quite simply from your criticisms. You rightly criticise the excessive creation of credit by commercial banks, thus the solution is simply to clamp down on this credit creation and make up for that with more central bank created money. 100% reserve banking is one option, though 50% might do.

    Also I wrote an article which attacks one of the most basic banking activities: borrowing short and lending long. You might be interested. See:


  10. Hi Musgrave

    Thank for reading my blog and your comment. If you think my blog is worth it please pass the link to it around.

    I did not propose any alternative as there is no need for it in my view:

    1. The traditional fractional reserve banking (i.e. lending with loan to deposit ratio less than 100%) is good. Why not come back to it provided:

    2. No bank is allowed to be too big to fail. So if it fails so be it. Its owners should lose their capital and the depositors are paid insurance money (which should be clearly spelled out as the service), and...

    3. The bankers who engineered the current crisis through fraudulent pyramid scheme must be banged up for very many years and their wealth (and the wealth they passed to their family and others) is confiscted. This is not only for the purpose of recovering some money (only fair in the light of the spending cuts). Such action will be a warning for the next generation of bankers what will happen if they indulge in fraud (even under the name of "financial innovations").

    To be honest a few good proseutors are needed to sort out the banking system. I do not see a need for banking system reform. As I wrote in my article "enforcing the law is the best regulator". Sorting out the fraudesters should be more than sufficient.