(The following testimony was submitted on April 13, 1994 to the 
Committee on Banking, Finance and Urban Affairs, of the U.S. 
House of Representatives. It was written by Christopher White, 
contributing editor of Executive Intelligence Review [EIR] 
magazine, and Richard Freeman, of EIR's economics desk.)

[From the May 30, 1994, *The New Federalist*.]

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Mr. Chairman,

It is now just over one year ago since Lyndon LaRouche, the 
editor of our magazine, put forward a March 9, 1993 proposal to 
levy a 0.1 percent tax on the sale of all the various mutations 
of financial transactions known as "derivatives."

The intent of this proposal was to permit constitutionally 
mandated institutional authorities to regain control over 
"runaway" deregulated electronic financial market places. The 
proposal will determine what the magnitude of the threat posed to 
the generality by derivatives is; and, to create the 
circumstances in which the structure of derivatives markets might 
be properly investigated. Moreover, the tax constitutes a precise 
means to surgically lance and dry out the derivatives bubble, to 
eliminate it within weeks.

The derivatives market, in which there are $16 trillion in 
derivatives holdings held by commercial banks and financial 
institutions in the United States, with an annual turnover 
trading volume of $300 trillion, is the greatest bubble in 
history. It dwarfs the Mississippi Bubble in France and the South 
Sea Island bubble in England. This bubble, like a cancer, has 
penetrated and taken over the entirety of our banking and credit 
system; there is no major commercial bank, investment bank, 
mutual fund, etc. that is not dependent on derivatives for its 
existence. These derivatives suck the life's blood out of our 
economy. Our farms, our factories, our nation's infrastructure, 
our living standards are being sucked dry to pay off interest 
payments, dividend yields as well as other earnings on the 

Need for action has long been evident. In testimony by these two 
authors to this committee on October 28, 1993, entitled, "Tax and 
Dry Out the Derivatives Market, Don't Regulate It," we stressed 
the necessity of the 0.1 percent tax. On March 28, 1994, the 
chairman of this committee, Rep. Henry Gonzalez [D-Texas], 
stated, "I think ultimately the only way you could stop, in fact, 
overnight [derivatives trading activity, is] if you imposed a 
1/10th of 1 percent tax on those transactions. You'd see an 
immediate deflation."

However, what the violent events over the first three months of 
this year prove, is that while LaRouche's March 9, 1993 proposal 
is still vitally essential, it, by itself, will not be sufficient 
to control the emerging situation. Events have far advanced. *The 
derivatives transactions which are subject to taxation are in the 
process themselves of collapsing. What is needed now is an answer 
to the question: Is there life after the derivatives bubble has 
been and gone?*

That which was feared, is in progress. That which the proponents 
of derivatives insisted could not come to pass, because of their 
sophisticated methods of "risk assessment" has come to pass. The 
supposed liquidity of the market, allegedly proved by computer 
simulations, dried up overnight. The mere catalogue of wreckage 
shows losses of the size that even a few years ago would have 
been unthinkable: from the $600 million lost by speculator George 
Soros's Quantum Fund on one day, Feb. 14, 1994; to the $1 billion 
loss of Steinhardt Management's hedge fund; to the early April 
bankruptcy liquidation of the entire market holdings of the $600 
million in assets, exotic mortgage securities derivatives of the 
David J. Askin's Hedge Funds. This same process of mega-losses is 
occurring around the world.

To those who congratulate themselves that they "got through" this 
period, we offer this timely warning: Those whom the gods would 
destroy, they first make mad. *This is a systemic crisis; we are 
now in the midst of an ongoing, snowballing systemic collapse, of 
which the events of the first quarter of 1994 are merely a tiny 

It is time that Congress, through its appropriate committees, 
begins to discuss the question of how our national monetary and 
financial affairs might be reorganized such that national life 
can continue, after the collapse of the biggest financial bubble 
in human history has run its course.

For which reason we append to this statement the vitally 
necessary draft legislation intended to reorganize the Federal 
Reserve System, through the re-establishment of a National Bank, 
the Third such National Bank in the history of the Republic. This 
is the first order of business.

Such a proposal is consistent with Article 1, Section 8 of the 
Constitution, in which Congress is allotted the power to raise 
taxes and create money and credit.

With an ongoing financial collapse, the time has come to 
reappropriate those powers which from the beginning were 
allocated, for cause, to the constitutionally created branches of 
government, that the General Welfare provisions of the 
Constitution might once more inform the laws of the land in 
substance as well as intent.

What is now under way can only be efficiently addressed by act of 
government. There is no private agency which can provide the 
volume of credit required to ensure the continued functioning of 
national life. There will shortly be no private agency with 
credit anywhere in any case. Federal government must again become 
the sovereign source of credit, in the form of Treasury note 
issues, providing banking agencies with the means of issue to 
finance the economic activity of the country, thereby eliminating 
the subversive "discounting" practices of the Federal Reserve, 
and the so-called "Keynesian multiplier" methods of money 
creation through manipulation of federal debt.

The destruction of inflated financial assets over the first three 
months of the year to date exceeds the havoc wrought by the stock 
market crash of October 1987. The nominal bill for such "losses" 
during the first quarter will, in the not-too-distant future, be 
confirmed to start at about $2 trillion. Such "losses," under 
detailed investigation, will turn out to be about 14-15 percent 
of the notional value of all derivatives contracts traded, 
swapped, or whatever else it is they do with them.

If we, as a country, were not so idiotically attuned to the day- 
by-day, minute-by-minute jerking around of the "Down-Jones" Index 
as our basic indicator of the economic health of the universe as 
a whole, this elementary reality would have been grasped already.

The initial losses of the first quarter are only the beginning. 
There is the proverbial other shoe left to drop. The "blow off" 
of the remainder of the bubble is going to make clear that this 
country has been living in the equivalent of "loud cuckoo land" 
for about a generation. Over the course of that generation, there 
have been no "recoveries," there has been no "rebuilding of 

There has been looting and asset stripping. There has been 
economic depression. That is shortly to come to the fore in the 
kind of rude way which our accumulated national fantasy life, and 
its televised mirror image, will find impossible to ignore. 
Obviously those who most violently dispute this now will soon 
find themselves among the ranks of the most rudely shocked.

The turmoil of the last three months is not a "market 
correction," despite all the analysts and investment strategists 
who proclaim about their proverbial 10-15 percent decline blowing 
the froth off an over-heated "bull-run." Nor is it merely a 
matter internal to the market. What is going on is without 
precedent in human history.

There is a global financial collapse in progress -- a global 
financial collapse which was already in progress before the 
beginning of the year. From 1993 onward, from Chile, and the case 
of the Codelco raw materials company; to Argentina, and its bond 
and stock market; to Venezuela and the case of Banco Latino; to 
Spain and the multi-hundreds of millions loss of that country's 
fourth-largest bank, Banesto; to the United Kingdom and the Hong 
Kong and Shanghai Bank-owned Midland Bank; to France and the case 
of the multi-billion dollar loss at Credit Lyonnais; to Germany 
and the $1 billion plus loss at Metallgesellschaft; to the 
reputed several billion dollar losses at Malaysia's central bank, 
and the banks of Indonesia.

What is developing is global in scope. The losses are all related 
to derivatives trading. Sound companies and industrial concerns 
are being sacrificed to the vagaries of derivatives. Germany's 
Metallgesellschaft, the country's 14th largest industrial 
concern, will now lay off one-fifth of its work force, and asset- 
strip its operations to pay for the loss.

This committee is correct to highlight the activities of the 
hedge funds. They engage in the most wildly speculative behavior. 
Hedge funds are, for the most part, offshore, unregulated 
gambling casinos, relying on mountains of leverage. They are 
specifically constituted, by having 99 or fewer U.S. investor 
partners, to circumvent the Investment Company Act of 1940, which 
would otherwise regulate them. Hedge funds work on anywhere from 
5 to 1, up to 50 to 1 leverage. That means for every $1 billion 
of the hedge fund's own money which it has under management, it 
borrows from $5 to $50 billion. The over-300 hedge fund's have 
$75 billion in assets under management, meaning they could 
control an astounding amount of publicly traded bonds and stocks 
of anywhere from $375 billion to $3.75 trillion in value. By 
comparison, the average trading volume on the New York stock 
exchange is but $11 billion daily.

But every congressman should ask the obvious question: If for 
every $1 billion the hedge fund puts up, the hedge fund is 
getting from $5 to $50 billion from someone else, isn't that 
other party, lending the $5 to $50 billion, far more important? 
The answer is, of course. The committee must note the dominant 
role of the commercial banks, especially the Morgan banking 
group, and the investment banks, who lend the money to the hedge 
funds, and use the hedge funds as their "bird dogs," having the 
hedge funds make the speculations that the commercial and 
investment banks would be too embarrassed to make on their own. 
Not only that, but every congressman should know that the 
commercial banks put money from their own accounts into these 
hedge funds, and it is claimed, put money from the banks' trust 
departments into these hedge funds.

The largest derivatives trading banks are: Chemical, Citicorp, 
J.P. Morgan, Bankers Trust, Bank of America, Chase Manhattan, 
First Chicago, and Republic National Bank of Edmund Safra. Morgan 
Bank, and the Bankers Trust which it set up in the 1903-07 
period, and controls to this day, control together 31 percent of 
the $12 trillion of derivatives holdings of the major commercial 
banks. Morgan dominates derivatives trading. Among the investment 
banks, the largest derivatives traders are: Morgan Stanley; 
Goldman Sachs; Salomon Brothers; Lehman Brothers and Merrill 
Lynch. These are the institutions that control the hedge funds. 
These are the institutions whose activities, above all, must be 
investigated and controlled.

Moreover, there is an equally huge scandal. It is open knowledge 
that the entire financial market structure of the United States 
has been artificially rigged for the last three and a half years. 
Short-term interest rates were set at 3 percent and long term 
rates at 6.5 to 7 percent, the largest spread in post-World War 
II history, to benefit and enrich the commercial and investment 
banks who made derivatives plays on this spread. The losers on 
this operation were the American population, which paid dearly to 
"bail out" the banks. [CN Editor -- This sweet deal for bankers 
was also covered on the Saturday, June 11, 1994 "News From 
Neptune" show. I will try to feature excerpts in an upcoming 
"Conspiracy Nation".]

Oversight on the markets must begin with how the Federal Reserve 
Board of Governors, and the Federal Reserve Bank of New York, 
working with the Treasury Department, starting in the Bush 
administration, rigged this hideous operation.

Thus, the danger of derivatives trading and its damage is not 
limited to headline catching speculative excesses, and failures, 
of some outfits like the now notorious, U.S. legal-code-evading 
"hedge funds." There may be the financial, or electronic, 
equivalent of dead bodies left by the side of the financial 
version of the electronic superhighway. But they are the result 
of a pile-up, not its cause.

The cited cases all involve the use of financial derivatives.

Our estimate of losses sustained during the first quarter of 1994 
is not, however, based on adding up reports of losses sustained 
by individual banks, corporations or funds. The whole so-called 
asset base on which the derivative bubble depends has been 
devalued. The ongoing devaluation of assets has set in motion a 
collapse which proceeds as the so-called leverage, or pyramiding, 
of the derivatives transactions unwinds. In this it is not only 
the most egregious which are affected, but all, for all financial 
assets are being devalued.

The ongoing financial collapse is characterized by the 
application of "reverse leverage" against those institutions and 
banks which had resorted to the use of leverage or pyramiding to 
inflate their so-called gains, or nominal so-called assets.

The increase of interest rates, long-term as well as short-term, 
has been the trigger for the process by which the bubbled assets 
have been deflated, and the effects of reverse leverage, 

For example, there are over $3 trillion of U.S. government 
securities held by what the Treasury and the Office of Management 
and the Budget are accustomed to call the "public." Bond yields 
have risen by almost 20 percent since the beginning of the year, 
25 percent since October 1993. Since prices and yields move 
inversely, it is merely conservative to assume that the face 
value of the bonds has shrunk by as much as the yields have 
increased -- $600 billion on that account alone. This would be 
100 times what George Soros's Quantum Fund reported its losses to 
be over the days between Feb. 10 and Feb. 12.

The same approach can be taken to inspect "collateralized 
mortgage obligations" in their "principal only" and "interest 
only" strip form. Mortgage rates have risen as fast as have the 
yields on the Treasury's debt. Municipal bonds, too, and more 
exotic such instruments as, for example, the secondary market in 
so-called "emerging country" debt.

Now, U.S. Treasury bonds, whose world-wide daily trading volume 
was estimated at $300 billion one year ago, increasing by 100 
percent and more in the twelve months to February and March in 
exchanges in Chicago, London and Paris, are the core of the 
"hedging" operations undertaken by derivatives dealers. Borrow, 
against bonds, borrowed or held, to finance positions for or 
against various currencies, "hedged" back into something else, 
and so on.

It was less than one year ago that the International Swap 
Dealers' Association began to insist that "notional value" was 
not a useful way of looking at derivative exposure. Better, they 
insisted then would be "replacement" cost. This because, even a 
year ago, the notional sums that had been generated out of 
whatever electronic device they employ had grown to mind-boggling 
proportions. "Replacement cost" shrank the numbers back to more 
manageable proportions.

The difference between the two was a measure of the leverage, or 
pyramiding, applied from original "position," at cost, borrowed 
or not, to notional value.

The 20 percent increase in bond yields [CN Editor -- Apparently 
this means, in other words, the decreasing of the actual value of 
the bonds.] has undone a lot of the accumulated leverage that has 
been built into the world monetary system. For example, "hedge 
funds" can be leveraged up to 100 times, in which case, a 1 
percent movement is sufficient to wipe out the collateral or 
"margin" position. "Hedge funds" disposing, according to "Mar- 
Hedge" and others, of around $100 billion in total assets, are 
typically leveraged 10 to 15 times. A movement against them of 
6.6 percent to 10 percent on the notional values at stake, wipes 
out all their margin or collateral.

The matter is not the unwinding of leverage against hedge funds 
alone, but the whole accumulated mass of some $16 trillion 
notional so-called value in the United States -- and $25 trillion 
worldwide -- unwinding against everything else.

The bubble has been premised on a perpetuated fraud about the 
growth of the earnings of the U.S. economy. There has been no 
growth in the earnings of the U.S. economy. There has been no 
growth, not in the U.S. economy, not in the world economy, since 
the period 1967-70.

The country needs a reorganized, constitutional credit system. It 
needs such, so that we can begin to do the things which most 
living Americans are too young to remember their country ever 
having done. We need to create qualified employment for our 
people, through rebuilding our basic economic infrastructure in 
transportation, power generation, and water supply, and in our 
attenuated capabilities for capital goods production.

Credits issued for such purposes will generate more wealth than 
their original cost. We can create 6 million productive and 
decent-paying jobs in infrastructure and manufacturing and 
agriculture. The world economy must likewise be reorganized 
around development programs, which Mr. LaRouche has specified. 
This includes the "Productive Triangle" for the development of 
the Eurasian land mass, and the "Oasis Plan" for the development 
of the Middle East. This latter plan, which includes irrigation, 
and cheap abundant nuclear power, would provide the rock-solid 
basis for the praiseworthy Israeli-PLO peace process to succeed.

The collapse of the biggest financial bubble in history requires 
urgent action; it also provides the opportunity to put the 
country back on its feet, and under its own law.

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