How Wall Street is making its billions | Hacker News Reader

How Wall Street is making its billions

blogs.law.harvard.edu

86 pointssoundsop57 comments

So, to summarize:

1. The US government loans money to the banks at 0% interest

2. The banks buy treasuries at 2% interest

Why is the US government selling treasuries in the first place? In order to have money to bail out the banks' earlier losses.

Net-net: the banks are stealing money from US taxpayers.

Do I have this right?

That's basically what is happening. Wait until the inflation kicks in. See Argentina as an example: http://academic.reed.edu/economics/course_pages/201_f06/Case...

As far as I understand (from watching krugman-talks on youtube) the tragedy of argentina was that its debt was in $, which skyrocketed (as expressed in national currency) due to inflation. In case of US, external debt is in national currency, thus inflation might not have the same effect.

It won't have the same effect, but it produces another incentive -- to get rid of our national debt all we have to do is print our way out of it thus drastically inflating our money, and robbing all holders of US Dollars.

Again, from krugman-talks: no-one really needs to get rid of national debt, that is what Romania did in 80s and it was the worst economic move ever. You only need to service national debt, i.e. pay off interests, and exponential growth will take care of the rest. US debt right after WW2 is still there but it is peanuts in today's numbers.

> Do I have this right?

You're missing an important detail - this is nothing new.

Banks have always borrowed money from the US govt (and others) at X% and loaned it at Y%, where X < Y. (There's no point in that arrangement if X >= Y.)

With risk. What is the risk in buying US bonds?

The banks are borrowing short and lending long. There is a significant principle risk. If treasury yields spike up, the banks will take a bath.

Banks traditionally borrow short and lend long (savings accounts fund mortgages for instance). That is the risk they assume and what we pay them for.

But in this case, they seem to be borrowing long and lending short (or at least borrowing short and lending short).

It's not like the government is going to go demand it's money back like someone with a savings account is free to do.

And really, would you take $200k to the bank and deposit it at 0.5% interest and then take out a $200k mortgage at 6%? You might if you were concerned about liquidity (unsteady income?) and could get at the $200k in savings when you needed to. But if you didn't have that flexibility, it wouldn't make sense.

That the USD is increasingly worthless in the world economy.

That has nothing to do with the security of a US government bond.

Why not?

US bonds are redeemed for US dollars. If the dollar becomes increasingly worthless, why would you want to hold the bond?

Granted, I think saying the dollar is "becoming increasingly worthless" is being hyperbolic.

No, because the loans have to be repaid in USD. The only "risk" then is the opportunity cost of not investing in other capital classes.

exactly, and normally they borrow from other banks rather than the Fed, which the fed prefers. I believe the Fed only serves as the lender of last resort.

The carry trade is nothing new either, it's often used for example when borrowing rates in other countries are favorable compared to rates on US treasuries.

this is probably trivial economics but it always eluded me:

when the govt is giving out amount X money, and wants amount X + INTERESTX back. how can that work? where should INTERESTX come from when they only gave us X?

Time. The govt gives out X/year, not the final amount X. When they want it back, it comes from different 'tranches'.

This ensures, that there is always debt. Money has value only if there is debt and you must use some to get out of it. Why would you need it otherwise?

And the Fed gives its `profits' back to the government to spend. The ECB does the same (perhaps more roundabout).

Non-government deposit banks are legally allowed to create money (up to some reserve ratio).

Deleted comment

Stealing is taking another person's property without permission.

In this case, taxpayers handed over money to the government on the understanding that it would be used for the public good, to support common infrastructure and institutions. Instead it is being paid to the stockholders and employees of banks for doing exactly nothing: they are taking money from one federal account and moving it to another, producing no value for anyone but themselves.

So I guess, technically, it's not stealing. But it's a massive violation of trust that should be criminal.

> In this case, taxpayers handed over money to the government on the understanding that it would be used for the public good, to support common infrastructure and institutions.

Actually, our "representatives" did the handing, with the understanding that they'd be taken care of.

If you want to blame someone, blame the folks who did the handing. Unless you want to argue that they're blameless due to incompetence.

Of course, in the end, it comes back to us. We selected this clown college and gave them whiskey and car keys.

> So I guess, technically, it's not stealing. But it's a massive violation of trust that should be criminal.

No. Technically it is fraud.

How about if congress creates a "public option" bank. Then we can stop letting the private banks steal our money through tricks like this, and if that makes them collapse, so-be-it.

Honestly I think every major institution should have a public-option competitor. If it turns out that the private companies are worse than a government run version, then they must really suck.

The problem with a public option in this case is that the investment arms of these banks aren't providing a service to anybody, they are profit-making institutions in their own right. We the public are not "customers" of these banks, so we can't take our money elsewhere; they're using their own money.

The obvious government reform required here is stop lending the goddamn banks money at 0% interest.

I agree, but I think the general assumption is that if we stop giving bailouts and 0% loans, then the banks would fail and bring down the economy. That's why we should have public banks ready to replace them.

> Honestly I think every major institution should have a public-option competitor.

This was a common line of thinking from 1930 to 1980 or so, and lots of world governments had public run businesses. England is a great example actually - the English government owned a lot of business that got preferential treatment in the UK. Under Thatcher, most English government businesses were sold off and most public housing was sold to its current tenants. Here's a short list of some of the businesses that were sold off, you can click on each individual business to see how they fared and the changes to industry afterwards. Generally speaking, it was a very positive thing.

http://en.wikipedia.org/wiki/Margaret_Thatcher#Second_govern...

"British Petroleum was privatised in stages in October 1979, September 1983 and November 1987; British Aerospace in January 1981 and 1985; the government share in British Sugar in July 1981; Cable and Wireless in November 1981; Amersham International and National Freight Corporation in February 1982; Britoil in November 1982 and August 1985; Associated British Ports in February 1983; Jaguar in July 1984; British Telecom in November 1984; the National Bus Company in October 1986; British Gas in December 1986; British Airways in February 1987; the Royal Ordnance in April 1987; Rolls-Royce in May 1987; the British Airports Authority in July 1987; the Rover Group in August 1988; British Steel in December 1988; the Regional Water Authorities in November 1989; Girobank in July 1990; and the National Grid in December 1990."

On a personal note, I'm an American, and the worse service I've ever experienced have been at the hands of U.S. government run institutions: The various state-run DMVs, TSA, Homeland Security, the IRS, and the Post Office.

About the Post Office, by the way: I was frequently traveling 3-10 days at a time for work, and my mailbox would get completely full and my mail would get wrinkled and ripped and crushed. I ran into my postman one afternoon, and asked him, "Hey there - if I leave a note on my mailbox, can you stop delivering the bulk mail/junk mail? I don't want it, and my mail is getting ripped up and crushed from my stuffed mailbox." He said that the Post Office is paid to deliver the mail, and I have no say in what gets delivered. But, I could request the Post Office hold my mail and pick it up when I get done traveling.

Now, can you think of any private business that runs like that? Could you imagine the outrage if FedEx dropped off junk samples at your door without your permission and refused to stop? Look at how outraged we get at email spam - but you're both legally required to have a mailbox, and can't tell the Post Office to stop spamming you. This is what happens when a business can't go out of business - they hold no respect for their customers. I mean, how much nicer, more efficient, and pleasant would the DMV instantly become if they had a competitor for licensing and registering cars?

A form of "public option" bank does exist: a credit union.

Banks borrow money at 0% interest and lend it to the government at 2% interest. That 2% has to come from somewhere (hint: us). Now suppose the government could also borrow at 0% interest (or print its own money, for that matter). Then taxes could be put to better use than lining the pockets of people who don't actually create any wealth.

And then money would quickly become worthless, as all fiat currencies have.

Fractional-reserve banking

http://en.wikipedia.org/wiki/Fractional-reserve_banking

The US taxpayers are lending the money cheaply to banks and whoever else wants it. You can take part in this as well - go buy a government bond.

But can I borrow money at 0% interest from the Fed to do it?

> You can take part in this as well

Except for the free money part.

You know between this and the link posted the other day (http://www.rollingstone.com/politics/story/28816321/the_grea...) about Goldman Sachs I start to wonder if we that strive to create wealth with technology, with odds of failure stacked squarely against us, are really the smart ones. Sheesh. Too bad I have morals.

I've gone through that line of thought more than once and I've come to the conclusion that what we do or attempt to do is far more beneficial to human advancement than these bullshit 3 card monty games. That has to count for something, at least in terms of self-respect.

This is very true on the technical end of things. Where we (and by we, I mean the human race) are lacking is on the political end. I have come to the sad conclusion that there are not enough hackers in the political system. By a political hacker I mean people who are willing to experiment, to tinker, to say "I don't know if this will work, but let's try to find out", people who are empirically-minded and data- rather than poll-driven. I don't know how to solve this problem, either, as those of us of this mind-set tend to be more technically oriented than politically oriented.

It's sort of sad that the original intent of all of this stuff was to help make it easier to finance businesses. But people just found ways to make the buying and selling of these (shares,bonds,etc) as a product unto itself. The people that sit atop Wall Street are several layers abstracted from the actual generation of usefulness.

What is sad is that there is not much we can do. As voters we push a lever every 2 years as part of a very commercialized and marketed campaigns.

After that our participation ends except for the "little" paying of taxes part. The people we vote for are loyal to the companies and political interests that actually promote them into power.

Then there is the revolving door between government agencies and the banks and other big companies. All the SEC big wigs are the same big wigs that were running the major banks and investment companies. And the same goes for FDA, Department of Agriculture and any other government agencies. They might as well just merge the two -- if a company becomes "too big to fail", it should just become a part of the government because in effect that what is happening.

So if our goal is "to create wealth", technology is not the way to go. Create a bank and become "too big too fail" -- then we'll get 0% loans and we can boast about great profits that "exceed analysts expectations" every quarter.

> The people we vote for are loyal to the companies and political interests that actually promote them into power.

As jaded towards the political process as I am, this is not always the case. Sometimes these people actually believe in what they are doing. They are just financed by the industries that their actions are supporting because the industry wants to support someone that is supporting them.

That said, there's no real way to tell the percentage of these people vs. the people who sell their morals/principles to the highest bidder.

When I hear this sentiment, about this particular topic, or many others, I'm always reminded of Aikido http://en.wikipedia.org/wiki/Aikido

"Aikido is performed by blending with the motion of the attacker and redirecting the force of the attack rather than opposing it head-on"

Rather than lamenting Wall Street's unproductive money games and doing nothing about it, we could embrace the fact that these tools exist in the current economic climate and we could use these tools to generate the capital we need to further the goals of more productive pursuits.

Maybe VCs like Fred Wilson who have both financial leverage and disdain for shenanigans (technical term) could use capital generated by playing Wall Str's funds shuffling game to build meaningful companies who create things and create a more sustainable and entrepreneurial base on which to build an economy.

Use this tool against itself.

No? Naive?

It helps to think of it as a game. The money's just for keeping score.

The problem with this line of thinking is that games have rules. If people at the top, the bankers, the politicians, et al break the rules, the govt bails them out. If we break the rules, we go to jail.

It's like getting points by entering a cheat code.

To use the game analogy, there are always those willing to cheat to get ahead. Those that view the rules as just another obstacle, and if you can get around them you deserve the advantage that you get.

You have an odd notion of help.

> I start to wonder if we ... are really the smart ones.

You could join in their game by building companies on VC and flipping them. I hear thats popular with the kids.

> Too bad I have morals.

With morals you will never be truly rich.

So if you are part of the "False Economy" you get to make billions thanks to the suckers... err tax payers... who will bail you out, whilst everyone in the Real Economy gets to suffer the effects of the Financial Crisis.

Maybe it's time to go back to contracting work at financial institutions...

This sounds like what Enron was doing to cook it's books, just moving money around, except in this case the banks and the government aren't technically the same entity but heck they might as well be after the bail out.

The banks and govt aren't technically the same entity, but the govt may well be a controlling entity.

What are the odds that the controlling entity won't use the banks for political advantage, say lower loan rates in "red states"?

I wonder what fraction of the Treasuries sold at auction are purchased by the banks engaging in this behavior?

If it's a decent but not overwhelming amount, it could be causing the auctions to be priced hire and thus overall increase the government's take.

So it's not necessarily clear what's happening here...

Actually, to get $3b in return, consider how many billions of dollars they'd have to buy of Treasuries. (1yr are paying .37% through 4% on 30yrs, which they probably aren't buying.)

Anyone know offhand how much the banks did borrow?

This article is complete crap! At 3.6 Billion per quarter. Let say JP Morgain makes 10.8B a year. To make that with 2% yielding T-Bills the govt would of need to lend JP Morgan well more than 5.4 trillion.

That's where the "leverage" comes in. The exact mechanism is a little confusing to me, but I think it works like this:

Say you have $100. You can invest that $100 at 2% interest and earn $2. You end up with $102.

Leverage is complicated, and I'm not totally sure I understand how it work, but basically it allows you to amplify your money.

Instead of just investing $100, you take out a loan of $10,000 at 1% interest: you know you'll have to pay back $10,100, but you've already got that much. Now you've take that $10,100 and invest it at 2%, and you get $202 interest -- you now have $10,302. You pay back the $10,100 you owe, and you end up with $202, having earned 100x more than if you'd just invested without leverage.

Firstly, you're a factor 10 off: 10.8B is 2% of 540 billion. Secondly, 3% already reduces that to 360 billion. Thirdly, you missed the important word 'leverage' in the article.

Yea I did get the factor off. Leverage means using borrowed money to make more money. Other than the government where are you going to borrow at less than 2% interest rate? The financial institution does a lot more than buying t-bills.

Hum but isn't that in essence how the government is able to make deficits? I mean, without this process the gov wouldn't be able to fund itself other than by taxes.

So the federal reserve creates money by loaning at ridiculously low rates (currently it's not a bad idea if there really is a threat of deflation), banks then use that money to fund the government by buying treasuries and in such we just inflate the money supply? So banks are like facilitators for this to happen and get 2% back for it?

I dunno, I mean yes they make awe full amounts of money but can you really go about cutting out the middle men completely here?

without this process the gov wouldn't be able to fund itself

How exactly does one fund itself by lending money that is then used to buy bonds? The net result is 0 for the government. If they have money to lend, they would be better off just using that money in the first place.

http://en.wikipedia.org/wiki/Fed#Goals

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