Lies -- more lies -- and then there are financial firms

A blogger friend posted a lovely short article recently with the title “6 Reasons Why We Lie”. All of his reasons were absolutely spot-on. However, his final summary was the best. He maintained that the fundamental reason why people lie is because it mostly works. I want to add to this: it mostly works when nobody gets caught.

It made me reflect on the drama playing itself out at present on the world’s stock exchanges, and specifically in the financial sector of the big bourses. It’s really all about lies and more lies, and it has worked mostly in the past because nobody was caught out.

One of the principles of banking is that loans to customers need only be covered by a fraction of their value. It’s called the fractional reserve system. As an example, a bank may hold $100 in customer deposits but can lend out $1 000 to borrowers. In this way a bank actually “creates” money.

Furthermore, in past times, the reserve or federal bank of a country would have actual gold in its vaults to support the value of the currency used in the country. A couple of decades ago, this was abolished and most reserve banks of countries now have a stash of dollars to underpin the value of their currency. One can see how this could be a problem as the American dollar is seen to be rather shaky at the moment.

In other words, not only is your money at a bank not safe because the banks lend out much more than they get in, but your country’s monetary system also has not much of value supporting it either. Most people don’t realise this. It’s not exactly a subject taught at school. To have a look at what the banking system is about, watch the series of videos on YouTube called “Corrupt banking system”.

When Northern Rock, a United Kingdom financial institution, faced a run on the bank on September 14 2007, the rest of the UK and the world looked on with great pity as they watched the queues of people outside the branches waiting to withdraw their money. Little did all those onlookers realise that their money was as unsafely held in their financial institution of choice.

To safeguard the continued existence of this precarious financial system, the reserve or federal bank gives the undertaking to bail out the commercial bank if there are any problems. This means that Northern Rock is now owned by the UK government. However, what it really means is that the UK taxpayer owns a bank.

What’s worse for me is that this particular bank sponsors a football team — Newcastle United. I want to gag every time I see that. Do UK taxpayers know that they are sponsoring a football team? Do Man United supporters know? And do they know they are paying Ron Sandler, the new CEO, £1,08 million a year as a salary — out of tax money? Gordon Brown’s paltry little amount of £188 849 per year is quite sad next to that.

However, this was September 2007’s news. What new drama is unfolding right now that is again shaking the money tree worldwide? After having read an article on Sunday, in Der Spiegel, that there would be a riot on the stock exchanges worldwide the next day, I sat glued to my computer monitor watching video interviews on FT.com, the UK Financial Times. And let me just say, the awful video commercial for the courier service that ran before each video snippet made me swear never, ever to use that service. I have made a note!

The background to this latest financial drama is that during the last six months of 2007, Bear Stearns, one of the largest global investment banks and securities trading and brokerage firms, had suffered some fairly nasty losses due mostly to its exposure to subprime hedge funds as well as the start of litigation against the firm.

News didn’t get better in the new year, but the firm issued a statement on March 10 that everything was fine and that no liquidity problems were being experienced. The chairman was even out of the office having fun at a bridge tournament. On March 14, The Associated Press reported that JP Morgan Chase in conjunction with the Federal Reserve Bank of New York would provide temporary funding to keep the doors open.

Needless to say, the market reacted rather badly to this news with the shares trading down by 91% during the subsequent two days. By March 16, a full buy-out plan had had to be put in place. The business was bought by JP Morgan Chase at $2 per share or a total of $236-million. As JP Morgan didn’t have that kind of money, it received some help from the Federal Bank. That’s a bargain price for a company with 15 500 employees, offices worldwide and an amazing building in Manhattan said to be worth about $1,2-billion.

What was the main message on Monday March 17 from all these Financial Times experts, economists, financial wizards, specialist, consultants and whatever other titles they had? With serious faces, they announced that the markets would be falling because there was no more faith in the integrity of financial institutions. People in high places had lied. Shock, grief, take the sackcloth out of the cupboard.

But hello, people, they have been lying all along. In fact, every time a CEO opens his mouth at an AGM (annual general meeting) you know he is going to lie. The picture is never that rosy! Whether he gets caught or not is the only variable. And for all those who are chewing their fingernails to the bone, don’t. Although we haven’t seen the end of the drama in the financial markets, it will all be resolved. The reserve or federal bank in whichever country hosting the next drama will just print more money. My money, such as it is, is on Germany.