How Wall Street is making its billions

http://blogs.law.harvard.edu/philg/2009/10/17/how-wall-street-is-making-its-billions/

by soundsop • 17 years ago

86 46 17 years ago

blogs.law.harvard.edu

seldo2• 17 years ago

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?

nsrivast• 17 years ago

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.

yafujifide• 17 years ago

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

jjs• 17 years ago

> You can take part in this as well

Except for the free money part.

wallflower• 17 years ago

Fractional-reserve banking

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

fnid2• 17 years ago

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...

lkozma2• 17 years ago

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.

anamax2• 17 years ago

> 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.)

aaronblohowiak3• 17 years ago

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

monos• 17 years ago

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?

bitdiddle• 17 years ago

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.

pmorici• 17 years ago

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.

anamax2• 17 years ago

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"?

kenshi• 17 years ago

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...

jeromec• 17 years ago

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.

Herring• 17 years ago

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

fnid2• 17 years ago

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.

aaronblohowiak3• 17 years ago

You have an odd notion of help.

aswanson• 17 years ago

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.

pyre3• 17 years ago

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.

drunkpotato• 17 years ago

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.

rdtsc• 17 years ago

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.

pyre3• 17 years ago

> 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.

ynniv• 17 years ago

> 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.

JustRick• 17 years ago

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?

joshu2• 17 years ago

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...

joshu2• 17 years ago

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?

nkassis• 17 years ago

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?

Confusion3• 17 years ago

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.

rebelvc2• 17 years ago

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.

seldo2• 17 years ago

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.

Confusion3• 17 years ago

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.

rebelvc2• 17 years ago

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.

known• 17 years ago

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

How Wall Street is making its billions

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