A Question Of Confidence

Banking is built on Trust

By Melvin J. Howard

A nearly $820 billion stimulus package passed the House of Representatives last Wednesday without a single Republican vote. Bipartisan support an idea way of doing things but not practical. Frankly I am not sure by holding back on the votes did the Republicans do more harm to their own constituency. This is not a time as politics as usual we need bold steps now. Especially in our financial system we will also look at the banks past behaviour of appetites for homes through predatory lending followed by the foreclosure process. The US dollar is the backbone of the international monetary system. This trust in the US dollar is little more than a group psychological phenomenon that could collapse simply by people starting to question the faith they have in it like now.
Because people dont stop to think about it too much the above realization can initially cause some shock and confusion, and maybe also some hope. To get more comfortable with this very different way of looking at money and to get a better understanding of how the monetary system works, there is an excellent text, which was written in 1965 that you should be aware of. It is called "A Primer on Money, Banking and Gold" and I would highly recommend this to those who wish for a more detailed technical understanding of the mechanics that were described at a "big picture" level throughout on "How Money is Created".
A Mr. Peter Bernstein wrote this book all those years ago, when the monetary system was still bound to the gold standard and so was actually a bit different than it is today. Nevertheless Mr. Bernstein, who had a long and distinguished career in the banking industry, including many years at the Federal Reserve, wrote. Even though the monetary system has lost its gold backing and several other key changes have been made, much of this text is still relevant today. Professor James Tobin, Nobel Prize Winner in Economics and famous among activists for his Tobin Tax proposals, has also given the book much praise. It is very sad that such books are not widely available, nor incorporated into the core school curricula so that the monetary system could be clearly identified for what it really is. It is Mr. Bernstein himself, who sums up this dilemma over educating people about the monetary system so eloquently. He says in his book that when we "ask what the American Dollar is really based upon, we would have to say that it exists essentially on promises and bookkeeping machines. If anyone were to set up such a system by decree or legislation, it would probably never work. Indeed, it is just as well that most people never stop to realize that the money they earn for their efforts is only a number in a bookkeeping machine, or a piece of paper convertible into nothing more than another number in a bookkeeping machine."
The English word "credit" can be traced back to its Latin origins as being synonymous with "belief, faith, confidence, and trust". While many bankers may be aware that this trust is not well founded. This is because the system works to their advantage. If public confidence in the monetary system is to be shaken it will have to come from those hurt by it. But first they themselves will have to get to the point of questioning the system they have placed their trust in. The growing abuses of credit creation powers over the middle class and the poor, has made this period of awareness of these abuses.  The big banks and financial players (that is the ones too big to fail) whose loans start to default, but who can't have the defaults hit their books; need someone to get the money out from somewhere. Today’s predatory lending will take us to one of the cities where abusive lending practices are some of the worst in the country, and the state with one of the most bank-friendly foreclosure laws on the books. Interestingly it is also the place where the Federal Trade Commission has recently filed suit against Citigroup for the predatory practices of its subsidiary, Associates First Capital, in what could become the largest and most public case against a predatory lender ever seen in this country. This location is Atlanta, Georgia.

Behind the Curtain

The famous extreme capitalist and private property advocate, Ayn Rand, who was the author of "Atlas Shrugged", once said, "If money is the root of all evil, then what is the root of all money?" This might make you chuckle if you recall that Alan Greenspan, the Chairman of the Board of Governors of the Federal Reserve, worked with her extensively on her book "Atlas Shrugged", released in 1957, which many claim to be the most influential book since the Bible. 
This philosophy of objectivism largely rejects the idea that capitalism and capitalists should have any social goals at all, and promotes the idea that all acts and intentions should be purely selfish. Not surprisingly Rand's work was a huge hit with the powers that be in America at the time, hot on the heals of the McCarthy era. Her ideas are actually very different to Adam Smiths philosophy but we wont go into that here. In coming up with her rather extreme, but very influential, theories it appears that Ms Rand must have been skipping her physics lessons. The revolutionary developments in Physics that took place in the early 1900s in the form of Quantum Mechanics and Special Relativity her philosophy may have hit some stumbling blocks. Both of these radical developments in physics shook the foundations of Western thought premised on objectivity, independence of objects, the absolute nature of time, and certainty. Gradually this new way of looking at the world, which has many parallels with eastern religions, has replaced the old Newtownian (or classical) mechanics way of looking at the world in physics, and is seeping its way into other sciences such as chemistry and biology.
Today it is the economists, business-people and politicians who are the furthest behind in picking up on these turn-of-the century revolutionary developments in physics. The only thing they gleaned from this scientific revolution was knowledge of how to make the atomic bomb and blow things up in a spectacular fashion. What they could have learned is some pretty interesting flaws in their own field of economics. Not only are today’s mainstream economic theories, and philosophies like objectivism, outdated by being based on the Newtonian or classical worldview, but these same outdated views are reflected in our current monetary system. Which has now brought the world to its kness.
This digression into modern physics, while talking about the relationship between the Fed and the middle class as well as the poor, may seem rather odd. Nevertheless it brings home the point that money is a social and psychological phenomena and so the beliefs and "science" adopted by those that create money and control the monetary system must be scrutinized. Let’s explore further some of the foundations of contemporary mainstream economic theory that are challenged by the worldview shift brought about by modern physics, that the economists have yet to pick up on. It is rather ironic that mainstream economics, claiming to be so scientifically based, ignores the developments in the most objective of science of all. The emerging field of so-called Ecological Economics is doing a much better job of incorporating modern physics.
Lets just note here that these changes in perspective, quantum philosophy, forces us to think about time differently, to always acknowledge the interconnectedness of everything, and to recognize ever present uncertainty in everything. The private property markets of today do not operate in this fashion. Rather they treat people and objects as independent economic units, and discount the future as less important than the present. Furthermore they have limited mechanisms for coping with uncertainty remember Long term capital.

Federal Reserve needs to change

Under this old or classical worldview central bankers use more or less traditional techniques for exercising some control over the economy, and a large part of this is maintaining the confidence of the markets in the monetary system. So people that don’t have much money don’t factor into central bankers decisions very much at all. On the surface many might think that there is no relationship between the Federal Reserve and the poor to speak of. However this ignores the interconnectedness of everything and this is perhaps best considered within the context of the "Zero Sum Game".
Thus, according to Martin Mayer in the book "The Fed", only one fifth of commercial and industrial financing now comes from the banks. The rest comes from people and non-bank institutions that have accumulated lots of the existing money.
This has several implications. First the Feds powers over the market is more limited because there are so many non-bank financiers, so the Fed has to do whatever it can to please these non-bank markets and keep their confidence in the whole financial system alive. By necessity this means always pleasing the people that already have lots of money. Second, banks go looking all over the place for new people and entities to lend to since the domestic non-bank corporations abandoned them. This search has been a big part of banks overseas lending adventures and the phenomenal growth in lending to the sub-prime domestic markets over the past decade. The sub-prime market is a person with bad credit histories, which often correlates with low income. This loan market has grown 300% from about 75 billion in 1993 to over 400 billion by 2002. Previously the banks wouldn’t touch this market with a ten-foot pole, but in their never-ending search for new borrowers, especially at high yields, this was a huge growth area and the banks jumped on it.
In past years the practice of redlining has been common amongst banks, whereby banks mark maps with a red marker for areas they would and wouldn’t lend to and these distinctions were often made along racial lines. These days a similar map marking process might be used to distinguish between prime and sub-prime markets that is, who gets access to credit on reasonable terms and who gets lumped into the sub-prime category, which is where the exploitative terms of credit prevail.
Public concern over discriminatory practices in lending and the limited availability of credit in poorer neighborhoods lead to the passing of the Community Reinvestment Act (CRA) in 1977, under which bank examiners are supposed to check banks record of meeting the credit needs of the entire community including low to middle income groups. This means that the Federal Reserve has some responsibility for this but, as already noted, the Fed is mostly concerned with monetary policy, which means making sure that people that have the most money keep confidence in the monetary system. So as Martin Mayer points out in "The Fed", "discrimination against low income people in lending operations was a subject guaranteed to be of no interest to the Federal Reserve System". And as Kenneth Thomas, a Wharton School lecturer on finance points out, "banks are always happy with the ratings given by the easiest CRA grader in the business", meaning that the Fed doesn’t take the CRA review of banks too seriously at all.
Mayer also notes in "The Fed” "Both publicly and privately, the Fed has always refused to acknowledge the existence of discrimination in any part of the American banking system.
Business Week reported on a study commissioned by the Fed that found that 50% consumer spending in the year 2000 was attributable to the top 20% of income earners. Also, amazingly, 80% of directly held equity or stocks was attributable to the top 20% bracket. The conclusion of this study was that the economic boom of the middle to late 90s was almost entirely driven by the spending of the top 20% of earners, whose spending in turn was driven by confidence derived from an inflated equity market. Now that the markets are sliding this spending has stopped, we are now into recession, and layoffs are increasing in response to low company earnings. What then is a Federal Reserve Chairman to do? It seems his role is to keep the stock markets up and keep the top 20% - the speculator class - happy. So maybe its not just that the poor are irrelevant to the Feds decisions, but the irrelevancy may run as high as 80% of the American people! Not to mention the rest of the world.

Atlanta's "Freedom Walk"

In December of 2002 there was much celebration in Atlanta over the fact that Georgia has now produced two Nobel Peace Prize winners - Martin Luther King Jr and, most recently, former president Jimmy Carter. In fact, the King Center and the Carter Center, dedicated to both the memory and missions of these two Peace Prize winners, lie only about one mile apart and there is a walking path connecting the two. This walk, starting on Auburn Avenue, birthplace of King and home to the King Center, has been described as that from "Civil Rights to Human Rights" in the local Atlanta news and follows a road called "Freedom Parkway".
"It must be a great walk!" But take the wrong turn and you can tell certainly financial freedom was not evident - instead, foreclosure was, with some streets dotted with several homes in foreclosure.
Keep going and you will end up at the Fulton County Courthouse in downtown Atlanta. Lining the steps throughout the day were a bunch of mumbling lawyers with piles of papers that they were reading, one after the other just like this:
Excerpt: Fulton County Courthouse January 2007 Foreclosure Sale
These lawyers were auctioning off the thousands of Atlanta homes in foreclosure that hit their books in the month of December. Most of the homes were going straight back to the banks. Don't be fooled by the location of the auction - just because it takes place outside the courthouse, "outside" is the operative word. There's none of this "getting your day in court" when it comes to foreclosure here.
Foreclosure statistics from the Atlanta Foreclosure Report where most of these homes were that were being auctioned off by the collection of mumbling lawyers on the courthouse steps. Consistent with studies done on foreclosure in other cities, the data showed the highest rates of foreclosure in predominantly African American neighborhoods. Pondering all this, I departed the courthouse steps and headed back towards Auburn Avenue.

History of Black-Owned Financial Institutions

Back along Auburn Avenue, you can pass by the modern Atlanta Life Insurance Company building and then, heading east towards the King Center, passed by many buildings in disrepair. You can just make out the words on the signs of some of the buildings, and, if you know your history, you can try and imagine what were going on in and around them years ago - for Auburn Avenue were once the hub of black economic activity in Atlanta and a key source of capital for African Americans.
Along this stretch of Auburn you pass by the Apex Museum, and you can watch a movie called Sweet Auburn - Street of Pride.
That excerpt from the Apex Museum's video "Sweet Auburn - Street of Pride", narrated by Cicely Tyson and Julian Bond, includes a short history of some of the major black-owned financial institutions that emerged during the early twentieth century, some of which are still with us today. 
It's definitely not easy to read about the history of black owned financial institutions, for not very much history has been written about them. Professor Alexa Benson Henderson at Clark-Atlanta University wrote a book in 1990 called "Atlanta Life Insurance Company: Guardian of Black Economic Dignity" where she described this hole in American history as follows ... "I was discouraged...by the dearth of sources, printed or otherwise, on many of the significant individuals, groups and organizations that have been associated with black business development in Atlanta and elsewhere. Sadly, many of these inspiring stories are lost forever."
The Atlanta Life book opens a window to a whole branch of US financial history that has been largely ignored. Black-owned financial institutions sprung up in many places following the end of slavery, initially taking the form of community and church-based mutual aid associations. In the late nineteenth and early twentieth centuries there was no federal tax and no such thing as social security, unemployment insurance, Medicaid and so forth. As always, those at the bottom of the economic ladder were the most vulnerable to the contingencies of sickness, accident, job loss, death or imprisonment of a breadwinner.
Out of this environment and out of necessity grew a slew of mutual aid associations in black communities. In such a mutual aid group the cost of these risks is pooled by everyone paying a small weekly or monthly premium. Out of this pool are paid the costs of the few that experience the covered contingencies, such as death benefits to widows and orphans and weekly payments if you get sick and can't work. In this way the community as a whole bears these risks. This arrangement is more conducive to community development than having every member bear risk individually, which would tend to bankrupt whole segments of society.
Out of this collection of mutual aid societies in the South ultimately grew several extremely successful life insurance companies that, despite tremendous obstacles, are still with us today, including Atlanta Life on Auburn Avenue and North Carolina Mutual, born in another hub of black capital accumulation - Durham, North Carolina. These institutions have performed the near impossible - surviving for a whole century and through a period of brutal segregation, discrimination, the Great Depression and through having to win the confidence of their own communities in black owned and operated financial institutions.
Around the time these insurance companies were starting to grow, another key segment of black finance was emerging - the black owned banks. For example, Citizens Trust Bank opened up on Auburn Avenue in 1921 to meet the credit needs of the black community, to promote savings and the old-fashioned principles of "thrift", and to promote homeownership. Through all that happened in the twentieth century, Citizens Trust Bank is also still with us today.
These and other black-owned institutions played a significant role in the accumulation and distribution of capital in African American communities throughout the twentieth century. It is no coincidence that the communities around them, such as the Auburn Avenue area, developed into economic hubs. Banks and insurance companies pool deposits and premiums and then invest them in things like home mortgages, office buildings and business loans. To the extent these pooled funds were invested back into local communities, further economic development of the communities was assured. Well, as the years went by and even as segregation continued, white financial institutions began to see that money could indeed be made off black customers and they began to compete fiercely for this business. Ronald H. Bayer's book "Race & the Shaping of Twentieth Century Atlanta" sums up this situation as follows: "The success of these black institutions had proved to the white financial community that blacks were good mortgage, bank and insurance risks. The decisive factor has not been the [white] citizenry's quickened sense of charity or prosperity. As the men along Auburn Avenue often murmur wryly . "Dollars, you see, are not segregated".
Often with deeper pockets, bigger marketing budgets, more experience and privileged access to the legislature, white financial institutions had many advantages in acquiring black customers, to the detriment of the customer base of the black institutions.
As the era of state sanctioned segregation was coming to an end in the South in the 1960s and 70s, a different form of segregation was already rampant in both the North and South - financial segregation. The dominance of white institutions providing financial services to black customers soon led to a situation where accumulated capital from premiums and deposits were not being reinvested back into those communities but, rather, flying away to ventures in other areas. In such a situation capital is increasingly drained out of the local community. It is clear to me this is a very different financial war this time. Instead of domestic it has taken on a global perspective. Requiring and new way of banking the old redlining way of leaving certain segments out of the system is obsolete. Banking is based on confidence and that confidence must come from the population at large. Not just the elite financial institutions should reflect today’s society for so long that has not happened.