Friday, July 24, 2009

Here's what happens when you operate under an inapplicable paradigm

In September, the American Bankers Association reported that 27% of the nation's 8500 banks held preferred shares in Fannie and Freddie in their investment portfolios; 85% of the affected institutions were community banks, estimated to hold between $10 billion and $20 billion of the GSEs preferred shares.

Citing Midwest Banc Holdings as an example, Lemonides says many community banks "went from being healthy and well capitalized to the brink of insolvency -- not because the loan portfolios went bad but because they owned that preferred stock."

Last year when the government bailed out Fannie Mae and Freddie Mac they also wiped out shareholders. Many of the common shareholders were commercial banks and those preferred shares were part of their capital.

This wiping out of shareholders occurred because of a false belief that any financial help to these agencies put "taxpayers on the hook." There is simply no such "hook."

Under a floating FX/non-convertible currency system, where the government spends by crediting bank accounts, there is no such thing as "taxpayer on the hook." However, our policymakers behave as if it is true, which is somewhat equivalent to behaving as if we are on a gold standard.

So when Fannie and Freddie got that money it was deemed that "someone had to pay" so as to not put taxpayers on the hook.

In the end many banks paid and the cost was touched off a full-blown banking crisis as a result of wiping out much of the capital of hundeds, if not thousands of banks around the country.

Dumb! Dumb! DUMB!!

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