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What You Absolutely Need to Know About Money (Part 8)

It all starts with the Arab oil embargo of 1973-74.

The Arab members of OPEC proclaimed an oil embargo to punish the U.S. for aiding Israel. This action quadrupled the price of oil, roiling commodity markets, equities, bonds, and foreign exchange markets.

Energy prices soared. Speculation in oil exploration and production became feverish.

There was money everywhere.

Oil exporters in the Arab states were depositing their windfall "petrodollars" into big U.S. banks, who were in turn lending the money out as fast as they could.

By far, the largest recipients of the flood of money looking to be lent out were Latin American and South American countries. Thus, the new tens of billions of dollars banks had to lend were showered on sovereign states with glaring credit quality blemishes.

In the meantime, banks were lending hand over fist to the energy patch. Small banks were getting into the oil lending game, too – sometimes in spectacular ways.

By 1982, tiny Penn Square Bank, located in the Penn Square Mall in Oklahoma City, Okla., had made over $1 billion dollars of energy loans and resold them to money-center bank Continental Illinois National Bank and Trust Company of Chicago.

The loans went bad, quickly.

That shouldn't have been a problem for Continental Illinois, which had over $40 billion in "deposits." But it was a monumental problem.

That's because only 10% of Continental Illinois' deposits were FDIC insured.

In 1982, depositors were insured up to $100,000; so when news got out that Penn Square had failed and the loans it had sold to Continental were defaulting, Continental depositors began to panic.

Continental had been playing the "hot money" game, very aggressively. To increase its loan portfolio, it needed more capital, or deposits. It got them by offering high-interest CDs and borrowing in the fed funds market for overnight money and in the money markets by issuing commercial paper.

Its deposits weren't "sticky," meaning they weren't going to be left there by folks with savings accounts. They were hot money deposits that were now exiting the bank via electronic transfer at unheard of speeds.

The bank became insolvent in a matter of days.

Depositors who hadn't gotten their money out would lose untold billions if the bank was shut down. The Federal Reserve, the Treasury Department, and the Federal Deposit Insurance Corporation feared a run on other banks, including all the nation's big money-center giants.

The panic unfolded at breakneck speed, and it had to be stemmed.

So the FDIC effectively nationalized Continental, by taking an 80% ownership position, and declared all deposits insured.

In other words, not a single depositor would lose money. The FDIC with the full faith and credit of the government – better known as the American taxpayers – was backstopping the bank.

It seemed like it was over before it started. Everything calmed down; there would be no bank runs. All America's big banks were safe, effectively christened… too big to fail.

But the hits kept on coming.

By September 1982, Mexico had stopped servicing billions in loans it had taken from big New York banks. And Brazil was on the verge of defaulting on its massive borrowings.

The big money-center banks with their billions in petrodollar deposits were now all in big trouble. But they were smart.

The big banks knew full well that they could never sell bonds on behalf of Latin and South American countries with a history of defaults (the high interest the bonds would have to pay to attract investors would be a dead giveaway). So they made syndicated loans, enticing over 700 smaller banks to join them in fueling the profligate spending habits of socialist and mostly commodity-export-driven southern sovereigns.

You see, what the banks had figured out was that their friends in government would never let them fail. They would use the International Monetary Fund as a front to help bail them out.

It worked like a charm, and it's still working today.

The IMF was originally established to help tide over countries with short-term liquidity problems, by providing short-term loans accompanied by reform demands to fix their economies so they could pay back the IMF loans. But at that point, it would be forever transformed into a U.S. government-backed payment enforcer.

The beauty of having a seemingly multi-national enforcer such as the IMF force countries at risk of defaulting on imprudently lent loans to reform their economies to trigger growth again, was that all kick starts would require fuel in the form of IMF loans.

Thus the IMF lends to debtor countries so they can pay off the bankers who they owe and are behind to, so the banks don't have to write off their bad loans, and foreign sovereign nations can keep borrowing in capital markets (and from the same banks) to pay off bankers and the IMF.

It's called "extend and pretend."

Well, it's more formerly known as the Baker Plan, after James Baker III (Ronald Reagan's Chief of Staff and later his Secretary of the Treasury), who originated the game to save the likes of Citibank's then-chairman, Walter Wriston (the co-inventor of CDs and a huge lender to Latin and South America), himself chairman of Reagan's Economic Policy Advisory Board.

Whatever it's called, the extend and pretend game is now an institutionalized national treasure.

Of course it benefits the TBTF banks in yet another cockamamie scheme to make their lending lives eternal.

That's how we got to TBTF and how the TBTF banks get away with piling on more and more debt to borrowers that have no way of ever paying it back.

It's how the banks operate. It's the business they've created.

Next we'll look at how the capital markets are rigged. We'll see how banks manipulate them for massive profits, basically to offset the tiny spreads they make on the loans they will never be repaid on.

Then you'll start to see how the Fed feeds the banks a lifeline to keep their lending going and, as their top regulator, lets them get away with murder in the capital markets, so they can keep on making money (to lend out to consumers and American businesses, of course) to enrich the crony capitalists who suck Americans dry like filthy leeches.

Then I'll tell you how to beat them at their own game. But first, you've got to understand who the players are and how the game is really played.

Welcome to your life…

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. Curtis Edmark | May 16, 2013

    This reminds me of the episode of the original Bob Newhart show where Bob is having a life crisis because he thinks his profession as a psychologist is a waste; that he is not helping anyone. He goes to his old college professor played by Keenan Wynn to get a pep talk. What does his professor tell him: "It's all a crock!" So the Fed is all a crock too, huh??

  2. RePete | May 16, 2013

    And the hole keeps getting dug deeper and deeper. The big bank losses have been transferred to the citizens, indirectly, or directly as in the case of Cyprus. Now the worlds advanced economies are at the point of trying to save their currencies. The end result is massive unemployment, deflation in wages, huge social safety net cost increases, devaluation of currencies, and central banks that are running out of ammunition.

  3. CONTINENTAL ILLINOIS | May 16, 2013

    To say that Continental Illinois was a "hot money" institution is not entirely accurate. The bank was more dependent on the wholesale money markets than it should have been – however the reason for that was that the State of Illinois forbade branch banking, so Continental Illinois, as it grew to be the biggest bank in the American Midwest, also grew to be "the biggest bank in the world under one roof" (at 231 South LaSalle Street, Chicago, Illinois) in the words of author James P. McCollom (The Continental Affair – The Rise and Fall of Continental Illinois Bank), an excellent book. By law barred from growing a network of branches in Illinois, the bank had to depend on institutional money market funding sources, which are not as reliable as branch depositor relationships. Today, with the trademark and goodwill of Continental Illinois recently having been sold to private interests, Continental Illinois "Conti" is back, for the time being not as a bank but as a corporation. See

  4. yngso | September 23, 2013

    Many are saying that Bernankesaved the day in 2008 – and he probably did – at least temporarily.
    Then there are others like Jim Rogers who call him "Helicopter Ben"…

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