March 31, 2008
by Mike Whitney
"Instead of just propping up bankrupt banks, the governments should be democratising them - mobilising their assets to stimulate the productive economy, repairing infrastructure, researching and developing new markets, and refitting western economies to combat climate change." Iain MacWhirter, "The Red Menace"
The Federal Reserve is presently considering an emergency operation that is so risky it could send the dollar slip-sliding over the cliff. The story appeared in the Financial Times earlier this week and claimed that the Fed was examining the feasibility of buying back hundreds of billions of dollars of mortgage-backed securities (MBS) with public money to restore investor confidence and clear the struggling banks' balance sheets. The Fed, of course, denied the allegations, but the rumors abound. Currently the banking system is so clogged with exotic investments, for which there is no market, they can't perform their main task of providing credit to businesses and consumers. Bernanke's job is to clear the credit logjam so the broader economy can begin to grow again. So far, he has failed to achieve his objectives.
[ELAINE: I'm sorry, but the busy beavers in the Federal Reserve LLP CREATED this logjam in the first place. They did this because they wanted to make their buddies in the banking/investment world very rich. And this was done to create support for bizarre, stupid wars in the Middle East. And the oil con men in places like Texas dearly wanted these wars so they could raise the price of oil globally and make a killing. And so all these guys destroyed the dollar and our economy as well as wrecked our military. Indeed, this logjam is on a river of red ink. That is still flowing even as it is like the ancient maps showing ships sliding off the side of the flat earth. And is it no wonder that the buddies of Bernanke and Greenspan, like Friedman, love to talk about the 'Flat Earth'? HAHAHA. Flat as the World Trade Center.]
Since September, Bernanke has slashed interest rates by 3 percent and opened various auction facilities (Term Securities Lending Facility, the Term Auction Facility, the Primary Dealer Credit Facility, and the new Term Securities Lending Facility) which have made $400 billion available in low-interest loans to banks and non banks. He has also accepted a “wide range” of collateral for Fed repos including mortgage-backed securities and collateralized debt obligations (CDOs) which are worth considerably less than what the Fed is offering in exchange. But the Fed's injections of liquidity have not solved the basic problem which is the fall in housing prices and the persistent downgrading of mortgage-backed assets that investors refuse to buy at any price. In fact, the troubles are gradually getting worse and spreading to areas of the financial markets that were previously thought to be risk-free. The credit slowdown has also put additional pressure on hedge funds and other financial institutions forcing them to quickly deleverage to meet margin calls by dumping illiquid assets into a saturated market at fire-sale prices. This process has been dubbed the “great unwind”.
In the last six years, the mortgage-backed securities market has ballooned to a $4.5 trillion dollar industry. The investment banks are presently holding about $600 billion of these complex debt instruments. So far, the banks have written-down $125 billion in losses, but there's a lot more carnage to come. Goldman Sachs estimates that banks, brokerages and hedge funds will eventually sustain $460 billion in losses, three times greater than today. Even so, those figures are bound to increase as the housing market continues to deteriorate and capital is drained from the system.
The Fed has neither the resources nor the inclination to scoop up all the junk bonds the banks have on their books. Bernanke has already exposed about half of the Central Bank's balance sheet to credit risk. ($400 billion) But what is the alternative? If the Fed doesn't intervene, then many of country's largest investment banks will wind up like Bear Stearns; DOA. After all, Bear is not an isolated case; most of the banks are similarly leveraged at 25 or 35 to 1. They are also losing more and more capital each month from downgrades, and their main streams of revenue have been cut off. In fact, many of Wall Street's financial titans are technically insolvent already. The generosity of the Fed is the only thing that keeps them from bankruptcy.
[ELAINE: Some of these 'banks' have been around since the Gilded Era when corruption and power politics destroyed US democracy. Why on earth should we save J.P. Morgan's outfit? It is one of the FOUNDERS, nay, the CHIEF INSTIGATOR of the Federal Reserve's creation. Old J.Pirate Morgan owned Jekyll Island where the coup was plotted. If that pernicious organization were to fall, it would be like seeing the Mafia defeated. About time! But since J.P. owns the Fed, this Mafia group will use it to save THEMSELVES while dumping the rest of us overboard. One trick is for the Fed to seize all the savings in America via instituting 1% lending again which means no one saves money if they put their savings in any banks! They will be forced to hand it over the the J.PIRATES who will then make it 'grow' by using it to invest after taking their 20% profit off the top. I.e.: this is bankrobbery and the robbers are the BANKERS.]
It's generally accepted that the market for MBS will not improve until housing prices stabilize, but that's a long way off. Mortgages are the cornerstone upon which the multi-trillion dollar structured investment market rests, and that cornerstone is crumbling. If housing prices continue to fall, the MBS market will remain frozen and banks will fail; it is as simple as that. No one is going to purchase derivatives when the underlying asset is losing value. The Bush administration is pushing for a “rate freeze” and other clever ways to keep homeowners from defaulting on their mortgages, but its a hopeless cause. The clerical work needed to change these complex mortgages is already proving to be a daunting task. Plus, since 60 percent of these mortgages were securitized, it is nearly impossible to change the terms of the contracts without first getting investor approval; another fly in the ointment.
Also, the tentative plans to expand Fannie Mae and Freddie Mac, so they can absorb larger mortgages (up to $729,000 jumbo loans) is putting an enormous strain on the already-overextended GSE's. By attempting to reflate the housing bubble, the administration will only increase the rate of foreclosures and put the two mortgage behemoths at risk of default without any clear sign that it will help.
[ELAINE: but the savior will be the Fed. They will become the owner/landlords of most American homes. Isn't that SWEET? My ancestors ruled their baronies in Europe quite contentedly. Oppressing the peasants, making extractions, meddling in their housing affairs, kicking them out again if we decided to use the land for grazing sheep rather than raising wheat, etc. This is called 'feudalism' and if Americans are stupid, they will fall for these schemes being cooked up to 'save' them from things the Fed created in the first place.]
Yesterday's release of the Case/Schiller Index of the 20 largest cities in the country, shows that housing prices have slipped 10.7 percent in the last year while sales were down 23 percent year over year. That means that retail equity of US homes just took a $2 trillion haircut. Still, prices have a long way to go before they catch up to the 50 percent decline in sales from the peak in 2005. From this point on, prices should fall and fall fast; following a trajectory as steep as sales. Many economist expect housing prices to drop at least 30% (Paul Krugman and G-Sax) which means that $6 trillion will be shaved from aggregate home equity. In a slumping market, many homeowners will be better off just “walking away” from their mortgage instead of making payments on an asset of steadily decreasing value. Who wants to make monthly payments on a $500,000 mortgage when the current value of the house is $350,000? It's easier to pack the kids and vamoose then waste a lifetime as a mortgage slave. Besides, the Bush administration has no interest in helping the little guy stay out of foreclosure. Its a joke. All of the rescue plans are designed with just one purpose in mind; to save Wall Street and the banking establishment. Period.
There is a widespread belief that Bernanke has been proactive in addressing the turmoil in the credit markets. But it's not true. The Fed chairman has simply responded to events as they unfold. The collapse of Bears Stearns came just weeks after the SEC had checked the bank's reserves and decided that they had sufficient capital to weather the storm ahead. But they were wrong. The bank's capital ($17 billion) vanished in a matter of days after word got out that Bear was in trouble. The sudden run on the bank created a risk to other banks and brokerages that held derivatives contracts with Bear. Something had to be done; Rome was burning and Bernanke was the only man with a hose.
[ELAINE: Wrong instrument! Bernanke was holding the VIOLIN. And sawing away like mad. The smell of Bears Stearn's goose being cooked attracted the three headed hell hounds and the pirates who founded the Fed and who basically run it. So it took a mere phone call to arrange the dining room and to get the chef, Bernanke, to cook and carve up the Bear. The media wants us to think this is the other way around. It is NOT.]
According to the UK Telegraph: “Bear Stearns had total (derivatives) positions of $13.4 trillion. This is greater than the US national income, or equal to a quarter of world GDP - at least in "notional" terms. The contracts were described as "swaps", "swaptions", "caps", "collars" and "floors". This heady edifice of new-fangled instruments was built on an asset base of $80bn at best.
On the other side of these contracts are banks, brokers, and hedge funds, linked in destiny by a nexus of interlocking claims. This is counterparty spaghetti. To make matters worse, Lehman Brothers, UBS, and Citigroup were all wobbling on the back foot as the hurricane hit.
"Twenty years ago the Fed would have let Bear Stearns go bust," said Willem Sels, a credit specialist at Dresdner Kleinwort. "Now it is too interlinked to fail." (Ambrose Evans-Pritchard, UK Telegraph)
[ELAINE: And this is the fearsome Derivatives Beast who lives in the Cave of Death. Slaying it is a no-no. The dwarves have to first find some Siegfried to do the dirty work. When he kills the Dragon, it will tell him the truth and he will go out and seek to kill Wotan, the dwarves and everyone in his path. This is called 'World War III.']
Bernanke felt he had no choice but to step in and try to minimize the damage, but the outcome was disappointing. Bernanke and Secretary of the Treasury Henry Paulson worked out a deal with JP Morgan that committed $30 billion of taxpayer money, without congressional authority, to buy toxic mortgage-backed securities from a privately-owned business that was failing because of its own speculative bets on dodgy investments. Wow. The transaction turned out to be bad for shareholders, bad for employees and bad for taxpayers. It made the Federal Reserve look like the unelected and unaccountable oligarchy of bankster sharpies they really are. The only people who made out were the investors who were holding derivatives contracts that would have been worthless if Bear went toes up.
[ELAINE: HAHAHA. Bernanke had no choice? This creep knows just as well as I, what the hell is going on. But he has to enrich and protect the CRIMINALS who are wrecking America. This is because he is a TRAITOR. And should be arrested. Along with Greenspan. The $30 billion is a raid on the Treasury arranged by Paulson who happens to be a PIRATE, himself. And should be treated like pirates: captured and hung. And duh! The other people in this deal were all destroyed. But not the TOP GUYS who OKed this deal. They, being pirates, were happy to abscond with their multimillions. They sold out long before this.]
Still,the prospect of a system-wide derivatives meltdown left Bernanke with few good options, notwithstanding the moral hazard of bailing out a maxed-out, capital impaired investment bank that should have been fed to the wolves.
It is worth noting that derivatives contracts are a fairly recent addition to US financial markets. In 2000, derivatives trading accounted for less than $1 trillion. By 2006 that figure had mushroomed to over $500 trillion. And it all can be traced back to legislation that was passed during the Clinton administration.
“A milestone in the deregulation effort came in the fall of 2000, when a lame-duck session of Congress passed a little-noticed piece of legislation called the Commodity Futures Modernization Act. The bill effectively kept much of the market for derivatives and other exotic instruments off-limits to agencies that regulate more conventional assets like stocks, bonds and futures contracts.
Supported by Phil Gramm, then a Republican senator from Texas and chairman of the Senate Banking Committee, the legislation was a 262-page amendment to a far larger appropriations bill. It was signed into law by President Bill Clinton that December.” (“What Created this Monster” Nelson Schwartz, New York Times)
[ELAINE: Clinton was paid back quite handsomely. Note how his dear wife is being rewarded.]
Now the investment giants are lashed together by trillions of dollars of unregulated counterparty swaps. If one bank fails, it could domino through the whole system. Bernanke now finds himself in the unenviable position of having to make sure that all the equity bubbles are properly inflated so the banking system doesn't suddenly come crashing to earth. Meanwhile, the tumbling housing market has paralyzed the corporate bond and structured investment markets which means that Bernanke's job will get much harder, if not impossible.
[ELAINE: Bernanke's job is lookout man and get away car driver. He probably has to use Mapquest to plot his elaborate run from the cops. The cops being probably the Chinese and maybe even the Canadians! Only Canada has, as the guy in charge of their own banking system, a pirate from Goldman Sachs. So they can also kiss their assets goodbye.]
The Fed chief is now facing a number of brushfires that will have to be put out immediately. The first of these is short term lending rates, which have stubbornly ignored Bernanke's massive liquidity injections and continued to rise. The banks are increasingly afraid to lend to each other because they don't really know how much exposure the other banks have to risky MBS. This distrust has sent interbank lending rates soaring above the Fed funds rate to more than double in the past month alone. So far, the Fed's TAF hasn't helped to lower rates, which means that Bernanke will have to take more extreme measures to rev up bank lending again. That's why many Fed-watchers believe that Bernanke will ultimately coordinate a $500 billion to $1 trillion taxpayer-funded bailout to buy up all the MBSs from the banks so they can resume normal operations. Of course, any Fed-generated scheme will have to be dolled up with populous rhetoric so that welfare for banking tycoons looks like a selfless act of compassion for struggling homeowners. That shouldn't be a problem for the Bush public relations team.
[ELAINE: Oh, they trust each other! They conspire with each other. Oops, they backstab each other, too! Never mind. One thing is certain: they can't 'lend' to each other for the simple reason: THEY ARE FUCKING BANKRUPT!!!!! There is no money there.]
The probable solution to the MBS mess is the restoration of the Resolution Trust Corp., which was created in 1989 to dispose of assets of insolvent savings and loan banks. The RTC would create a government-owned management company that would buy distressed MBS from banks and liquidate them via auction. The state would pay less than full-value for the bonds (The Fed currently pays 85% face-value on MBS) and then take a loss on their liquidation. “According to Joseph Stiglitz in his book, Towards a New Paradigm in Monetary Economics, the real reason behind the need of this company was to allow the US government to subsidize the banking sector in a way that wasn't very transparent and therefore avoid the possible resistance.”
The same strategy will be used again. Now that Bernanke's liquidity operations have flopped, we can expect that some RTC-type agency will be promoted as a prudent way to fix the mortgage securities market. The banks will get their bailout and the taxpayer will foot the bill.
[ELAINE: They can't have a Resolution anything due to the hard fact, they have to first declare bankruptcy. This is why they are scheming like mad to create a new system that lets them float over this fact. They need to tap into the public purse to bankroll their reserves!]
The problem, however, is that the dollar is already falling against every other currency. (On Wednesday, the dollar plunged to $1.58 per euro, a new record) If Bernanke throws his support behind an RTC-type plan; it will be seen by foreign investors as a hyper-inflationary government bailout, which could precipitate a global sell-off of US debt and trigger a dollar crisis.
Reuters James Saft puts it like this:
“It is also hugely risky in terms of the Fed's obligation to maintain stable prices.... it could stoke inflation to levels intolerable to foreign creditors, provoking a sharp fall in the dollar as they sought safety elsewhere.” (Reuters)
Saft is right; foreign creditors will see it as an indication that the Fed has abandoned standard operating procedures so it can inflate its way out of a jam. According to Saft, the estimated price for this folly could be as high as $1 trillion dollars. Foreign investors would have no choice except to withdraw their funds from US markets and move them overseas. In fact, that appears to be happening already. According to the Wall Street Journal:
"While cash continues to pour into the U.S. from abroad, this flow has been slowing. In 2007, foreigners' net acquisition of long-term bonds and stocks in the U.S. was $596 billion, down from $722 billion in 2006, according to Treasury Department data. From July to December as jitters about securities linked to US subprime mortgages spread, net purchases were just $121 billion, a 65% decrease from the same period a year earlier. Americans, meanwhile, are investing more of their own money abroad.” ("A US Debt Reckoning" Wall Street Journal)
$121 billion does not even put a dent the $700 billion the US needs to pay its current account deficit. When foreign investment drops off, the currency weakens. Its no wonder the dollar is falling like a stone.
Bernanke should seriously consider the consequences of his next move before he acts. Once the dollar starts to free-fall, there's no telling where it will land.
[ELAINE: The elimination of the dollar is obvious. What on earth is the Amero, anyway? Our main trading partners all put tons of dollars in their FOREX reserves and now we will destroy these reserves by forcing them to turn over the money and have it revalued in the new, lesser currency. Back when Germany and Japan revalued their currencies with the dollar, each time, the dollar cutting its value by 50%, they had few dollars held in government accounts. Today, their central banks hold trillions of dollars along with China, all the oil selling nations and quite a few others. So forcing them to turn over the dollars with a 50% or greater haircut, is a VERY REAL possibility. Indeed, this is in lieu of another Bretton Woods Accord!
The only thing keeping this from happening is our need to not stab both Mexico and Canada in the back. So the Amero is the solution. Both of these nations will get a 1:1 exchange of their banking holdings of dollars or they will turn off the oil taps. This program has many dangerous side issues. One is, we still consume way too much oil and Mexico and Canada can't supply it all. And China might make a deal with the other oil pumping nations locking us out! Thus, the military option rears its ugly horned head.
The temptation to launch WWIII will be very strong for the US. The US is between a rock and a frying pan. Or rather, we will be a rock in a fire. The Amero solution is still very, very iffy. I would surmise that the northern half of the US might be sorely tempted to join with Canada and shove off from the strange political practices of the southern half of the country. I know that I would probably vote for something like this if the south keeps voting into office jerks like the Bushes. But then, voting for war mongers who pay no attention to the finances is a plague on all of our states at this point. It is just a lot of work, moving further north. Heh.
In economic chaos, countries do change their borders, sometimes, very rapidly.]
How is europe doing? Do they have cash? I noticed on the news the other day they were opening air lanes from there over here. Maybe their our hopes of buying all of these empty houses?
Posted by: Dutch | March 31, 2008 at 02:29 PM
Heh. We have some lovely houses in my village for sale. Cheap. Want to try some of them?
Posted by: Elaine Meinel Supkis | March 31, 2008 at 02:35 PM
After all, Renssalaer county was once owned by the Dutch. Settled by the Dutch. Many of the older families still here are descendants of the Dutch. Like the maple syrup people I wrote about. My next door neighbor was born in Amsterdam, even!
Posted by: Elaine Meinel Supkis | March 31, 2008 at 02:37 PM
I wouldnt buy a house, even if I could. Id rather build it me self, ARRR. I have operated with cash most of me life matey!
Posted by: Dutch | March 31, 2008 at 02:51 PM
Elaine,
I love reading your commentary but when it is lengthy and dispersed throughout Mike's post I find jumping back and forth between the two makes it difficult to follow his narrative.
I know your stuff is already in italics, however the material you usually have in italics is part of your narrative, just from another source. Any chance you could post it in a different color, or maybe place it at the end?
Maybe it's just me.
Thanks
Posted by: K | March 31, 2008 at 03:42 PM
Remember the restaurant in the movie,"Goodfellas". Remember how the boyz
racked up such a huge bar tab that they and
the owner both knew that if it didnt get paid the place would go belly up. Doing the only thing he could under the circumstances, the owner took on the "goodfellas" as "partners" Heh heh. From then on out, it was all downhill. The furniture,steaks,lobsters,liquor and cigarettes went in one door and out the other. This is what they called, "bustin' the
joint out".
How much different acting than this are our
own "goodfellas" on Wall St. and their enablers in the Fed Reserve,the Congress,and
last but not least, the executive branch ?
The last time the banksters went wild it was the S&L collapse, and that was in the billions.How are we to pick up this mess
with the numbers in the trillions? I think we're talking "real" money now.
Posted by: Gary Oppewall | March 31, 2008 at 04:29 PM
Hi Elaine,
I don't mind if you rip my article apart, but can't I at least get a photo of one of your dogs in the heading instead of that lousy banking-vermin Bernanke.
You are still my mentor even if I am a poor student.
Posted by: Mike Whitney | March 31, 2008 at 05:14 PM
When corporations, including the media, collude with the government to rob and suppress the people and have wars the people don't want, isn't that facism? They have the Patriot act and freshly built detention centres too. Just wondering.
Posted by: Pat O'Meara | March 31, 2008 at 05:27 PM
Not to change the subject, but I thought this might be interesting. Especially since monsanto just bought deruiter seeds. www.financialsense.com/editorials/engdahl/2008/03331.html
Posted by: Dutch | March 31, 2008 at 05:29 PM
Elaine, I mentioned this in an earlier post and maybe you can help or even one of the readers. Who and Why are all of these mining companies are getting bought up?
Posted by: Dutch | March 31, 2008 at 05:31 PM
This failure is much bigger than any RTC-type fix the geniuses think they might have come up with. The Fed as hero isn't the coup it appears to be. There has been lots of outrage over the very thought of letting the crooks in on the solution. Not only were they invited to participate, they were deputized and put in charge of a fiasco.
All other things being equal, the simplest analysis is the best. I think this means we are truly in the end game and the big unwind is about to happen. The SEC is a joke. They looked the other way while corporate and financial market crimes were committed. This reorganization simply put them out of their misery.
The Fed is going down for all this. Simple human motives always come into play no matter how complex and sophisticated the players and institutions. At this juncture it’s about spinning a body of allegorical tales that the public can wrap their head around. This is about establishing the blame. No way are the politicians going to take the blame for this. They put the Fed in charge and now they’ll walk away. The US Treasury knows they will step back at some point to take over the nation’s finances without private banks running the country.
I just don’t buy the notion that this will be about twenty thousand marauders versus three-hundred million other Americans who are about to take it permanently on the chin. The cooperation of the country will be essential once the writers crank out the screenplay, a director is hired, and the actors are cast and learn their lines.
Posted by: Cato | March 31, 2008 at 05:38 PM
I disagree that the North American Union would be good for us. It will lower minimum wage to $4.00 hour and everyone would be on government aid. It also gives up sovereignty of this country.
Why don't you encourage readers instead to let their congressional leaders know where they stand, NO bailout of the banks!!!
Did you know the Senate approved Social Security benefits for illegal aliens to start in 2008??? Vote these idiots out!!!
Posted by: Kah | March 31, 2008 at 06:07 PM
"Behind the ostensible government sits enthroned an invisible government owing no allegiance and acknowledging no responsibility to the people. To destroy this invisible government, to befoul the unholy alliance between corrupt business and corrupt politics is the first task of the statesmanship of the day."
Theodore Roosevelt, April 19, 1906
Posted by: rockpaperscizzors | March 31, 2008 at 06:25 PM
Mike, I'm sorry! Next time, I will try to get Fluff and the dogs to do something interesting.
But I had to do the cartoon.
About the comments: usually, when I do an article from somewhere, I have comments in a slightly different format. In this case, I tried something different. Mike's article are published all over the web. But some readers asked me to make comments because they felt he wasn't aware of the darker, personal side of the bastards he writes about so well.
In other words, he underestimates their criminality. Which I understand. We are all supposed to think a bunch of vicious traitors and pirates are actually upright citizens.
They are NOT. Not even slightly. Can't help but talk about that.
Kah, you are right. And not only that, the SS for the illegals will be sent overseas. Just what we need: more money bleeding away like crazy.
Posted by: Elaine Meinel Supkis | March 31, 2008 at 07:14 PM
Mike, I like your work very much, keep it up! I've been reading your work ever since it started to be published on Informationclearinghouse. It was your interview with Elaine there that lead me to Elaine's work too.
I don't think the Bernanke beaver detracts from your work at all, Mike. In fact I had a good laugh at Elaine's cartoon. I thought it was the perfect cartoon animal for Bernanke. If Bush is a monkey surely Bernanke has a beaverish quality to him!
Posted by: Christian W | April 01, 2008 at 08:19 AM
Yes, I try to please everyone here. Impossible task since everyone is not only interesting but varied!
Don't hesitate to tell me what to do [except 'go to hell'---heh].
Posted by: Elaine Meinel Supkis | April 01, 2008 at 09:29 AM
So where should we put our money during all this turmoil ? Any ideas would be much appreciated !
Posted by: barbara hazleton | June 04, 2008 at 11:55 PM