scary out there - there's blood on the streets."
- anonymous Wall Street trader
31 , the Federal Reserve dropped its benchmark interest
rate by 25 basis points to 4.5 per cent citing ongoing weakness
in the housing sector. As expected, the stock market rallied and
the Dow Jones Industrial Average soared 137 points. Unfortunately,
Bernanke's "low interest" stardust wasn't enough to buoy the markets
through the rest of the week.
the hammer fell. The Dow plummeted 362 points in one afternoon
on increasing fears of inflation, a slowdown in consumer spending,
a steadily weakening dollar and persistent problems in the credit
markets. By day's end, the Fed was forced to dump another US$41
billion into the banking system to forestall a major breakdown.
This is the most money the Fed has pumped into the financial system
since 9-11 and it shows how dire the situation really is.
Why do the
banks need such a massive infusion of credit if they are as "rock
solid" as Fed chairman Ben S Bernanke says?
As most people
now realize, the mortgage industry is on life-support. Many of
the ways that the banks were generating profits have vanished
overnight. The "securitization" of debt (mortgages, car loans,
credit card debt, etc.) has ground to a halt. What had been a
booming multi-billion dollar per-year business is now a dwindling
part of the banks' revenues. Investors are steering clear of anything
even remotely associated to real estate.
the banks are holding an estimated $200 billion in mortgage-backed
securities and derivatives for which there is currently no market.
This is compounded by $350 billion in "off balance sheets" operations
- which are collateralized with dodgy long-term mortgage-backed
securities - that provide funding for "short-term" asset-backed
commercial paper. ASCP has shriveled by $275 billion in the last
10 weeks leaving the banks with gargantuan liabilities. Bernanke
was forced to add $41 billion to keep the banking system from
slipping beneath the salty brine.
shows how powerless the Fed really is when it comes to changing
the overall direction of the markets. Sure, Bernanke and his buddies
in the Plunge Protection Team can goose the market by buying-up
futures and boosting the day's results. But that's just a short-term
fix. In the long run, the Fed has less chance of stopping the
market from correcting than it does of stopping a runaway truck
by standing in its path. Besides, the Fed cannot purchase the
banks' bad investments (CDOs, MBSs, or CP) nor can it reflate
the multi-trillion dollar housing bubble. All it can do is provide
more cheap credit and hope the problems go away.
the lower rates haven't even decreased the price of the 30-year
mortgage or made refinancing any cheaper. All they've done is
postpone the inevitable day of reckoning. In truth, they're just
a desperate attempt to perpetuate consumer borrowing while the
banks figure out how to offload their enormous debts.
That's what US
Treasury Secretary Henry M Paulson's $80 billion "Banker's Bankruptcy
Fund" is really all about; it's just the repackaging of subprime
junk so it can be passed off to credulous investors. Fortunately,
the public has "wised up" and isn't buying into this latest fraud.
As a result, the banks have taken another blow to their already-flagging
Fed cannot purchase the banks' bad investments (CDOs, MBSs,
or CP) nor can it reflate the multi-trillion dollar housing
bubble. All it can do is provide more cheap credit and hope
the problems go away.
In the last
two months, the pool of qualified mortgage applicants has contracted,
as has the market for massive merger and acquisition deals (private
equity). So the banks are probably doing more with the Fed's $41
billion injection than just beefing up their reserves and issuing
new loans. The market analysts at Minyanville.com summed it up
are taking the liquidity the Fed is forcing out there through
the discount window and repos. After using it to shore up the
declining value of their assets, they have excess to lend out.
Finding no traditional borrowers that want to buy a house or build
a factory, the new rules the Fed has set forth allow the banks
to pass this liquidity onto their broker dealer subsidiaries in
much greater quantities. These broker dealers are lending thus
to hedge funds and margin buyers who are speculating in stocks.
Remember, the Fed is powerless unless it can find people to borrow
the credit it wants them to spend. By definition, the last ones
willing to take that credit are the most speculative."
This is a
likely scenario given the fact that the stock market continues
to fly-high despite the surge of bad news on everything from the
falling dollar to the geopolitical rumblings in the Middle East.
Last month, the Fed modified its rules so that the banks could
provide resources to their off-balance sheets operations (SIVs
and conduits). If the Fed is willing to rubber-stamp that
type of monkey-business; then why would they mind if the money
was stealthily "back-doored" into the stock market via the hedge
explain why the hedge funds account for as much as 40 to 50 per
cent of all trading on an average day. It also explains why the
stock market is overheating.
of course, cannot go on forever. And it won't. Rate cuts do not
address the underlying problem which is bad investments. The debts
must be accounted for and written off. Nothing else will do. That
doesn't mean that Bernanke will suddenly decide to stop savaging
the dollar or flushing hundreds of billions of dollars down the
investment bank toilet. He probably will. But, eventually, the
blow-ups in the housing market will destabilize the financial
system and send the banks and over-leveraged hedge funds sprawling.
Bernanke's low interest "giveaway" will amount to nothing.
News ran a story last week which sheds more light on the jam the
banks now find themselves in:
shut out of the market for short-term loans are finding salvation
in a government lending program set up to revive housing during
the Great Depression.
Financial Corp., Washington Mutual Inc., Hudson City Bancorp Inc.
and hundreds of other lenders borrowed a record $163 billion from
the 12 Federal Home Loan Banks in August and September as interest
rates on asset-backed commercial paper rose as high as 5.6 per
cent. The government-sponsored companies were able to make loans
at about 4.9 per cent, saving the private banks about $1 billion
in annual interest."
now that the credit markets have frozen over, the banks are going
to the government with begging bowl in hand? So much for "moral
paper is short-term notes that businesses use for daily operations.
Because much of this CP is backed by mortgage-backed securities;
the banks have been having trouble rolling it over (Refinancing).
So - unbeknownst to the public - various banks have been borrowing
from the government-sponsored Federal Home Loan Banks (FHLB) so
they can cut their losses (or stay afloat?).
new rules the Fed has set forth allows the banks to pass
this liquidity onto their broker dealer subsidiaries in
much greater quantities. These broker dealers are lending
thus to hedge funds and margin buyers who are speculating
has extended $163 billion of loans to them, which means that the
risks that are inherent in supporting "dodgy banks that make bad
bets" has been transferred to FHLB's investors. The danger, of
course, is that - when investors find out that FHLB is mixed up
with these shaky banks - they are liable to sell their shares
and trigger a collapse of the system. This is a good example of
the dim-witted strategies that are being used to bail out the
banks. There are probably many similar scams underway just beyond
the publics' view.
weekend, Citigroup's CEO Chuck Prince got the axe. Citigroup,
which boasts more than 300,000 staff worldwide, has lost more
than 20 per cent of its market value from bad bets in sub-prime
mortgages. According to the Times Online: "The Securities and
Exchange Commission may investigate whether it improperly juggled
its books to hide the full extent of the problem."
is not a word that is taken lightly on Wall Street where traders
are now bracing for another massive sell-off of financial stocks.
Mr. Prince won't be alone in the unemployment line either. He'll
be accompanied by Merrill Lynch's former boss, Stanley O' Neal,
who got the boot last week when his firm reported $8.4 billion
in write-downs. Deutsche Bank analysts now "predict that Merrill
may write off another $10 billion of losses related to its portfolio
of sub-prime debts". (Times Online) That would wipe out 8 full
quarters of earnings and represent the largest loss in Wall Street
is bleak, bleak, bleak. The systemic rot is appearing everywhere
presaging ongoing losses for the financial giants and a long-downward
spiral for the markets. The banks are currently under-regulated,
over-leveraged and under capitalized. And now the sh** is about
to hit the fan.
chief Paul Volcker summarized the overall economic situation last
week at the second annual summit of the Stanford Institute for
Economic Policy Research. In his speech he said:
the circumstances seem as dangerous and intractable as I can remember...
Boomers are spending like there is no tomorrow. Homeownership
has become a vehicle for borrowing and leveraging as much as a
source of financial security... As a nation we are consuming...
about 6 per cent more than we are producing. What holds it all
together? High consumption - high leverage - government deficits.
What holds it all together is a really massive and growing flow
of capital from abroad. A flow of capital that today runs to more
than $2 billion per day. The nation is facing "huge imbalances
right. The country is in a bigger pickle than any time in its
230 year history. The credit storm that was engineered at the
Federal Reserve has swept across the planet and is now descending
on commercial real estate, credit card debt, and the plummeting
bond insurers industry. These are the next shoes to drop and the
tremors will be felt throughout the broader economy.
As this article
is being written, Reuters is reporting that Citigroup may be forced
to write-down as much as $11 billion in subprime mortgage-related
"Citigroup announced today significant declines since September
30, 2007 in the fair value of the approximately $55 billion in
U.S. sub-prime related direct exposures in its Securities and
Banking (S&B) business. Citi estimates that, at the present
time, the reduction in revenues attributable to these declines
ranges from approximately $8 billion to $11 billion (representing
a decline of approximately $5 billion to $7 billion in net income
on an after-tax basis)."
statement indicates a willingness on its part to come clean with
its investors but, in fact, they know that the situation is fluid
and there'll be hefty losses in the future.
securities (MBSs) and collateralized debt obligations (CDOs) will
continue to be downgraded as time goes by. According to the Financial
Times, one banker was having so much difficulty getting a bid
on subprime securities; he found the only way he could get rid
of them was through barter. He resorted to using a tactic more
normally associated with third world markets than the supposedly
sophisticated arena of high finance. "Barter is the only
thing that works," he chuckled, "It's like the Dark
Ages." The article continues:
mind the fact that the risky tranches of subprime-linked debt
have fallen 80 per cent since the start of the year; in a sense,
such declines are only natural for risky assets in a credit storm.
Instead, what is really alarming is that the assets which were
supposed to be ultra-safe - namely AAA and AA rated tranches of
debt - have collapsed in value by 20 per cent and 50 per cent-odd
respectively. This is dangerous, given that financial institutions
of all stripes have been merrily leveraging up AAA and AA paper
in recent years, precisely because it was supposed to be ultra-safe
and thus, er, never lose value." (Financial Times; Gillian
AAA and AA
assets - the top-graded tranches - have already been downgraded
by 20 per cent to 50 per cent !?! And the prices are bound to
fall even more because there is no market for mortgage-backed
securities. This is a bank's worst nightmare; an asset that loses
value and requires greater capital reserves EVERY DAY. In fact,
AAA rated MBSs have dropped 14 per cent in one month. It is truly,
death by a thousand cuts.
real reason that the subprime swindle mushroomed into a
humongous economy-busting monster is that the markets are
no longer policed by any agency that believes in intervention.
The US financial
system is now buckling beneath the weight of its own excesses.
The subprime contagion - which can trace its origins to the massive
expansion of credit at the Federal Reserve - has devastated the
housing market generating an unprecedented number of foreclosures,
record inventory, and a massive multi-trillion dollar equity bubble
which is now catastrophically deflating and wiping out much of
the mortgage industry in its path.
Its effects on the secondary market have been even more devastating
where pension funds, insurance companies, hedge funds and foreign
banks are left holding hundreds of billions of dollars of complex,
mortgage-backed securities and subprime-related derivatives which
are now destined to be downgraded to pennies on the dollar ravaging
The subprime meltdown has been equally damaging to myriad European
investment banks and brokerage houses. We've seen a wave of bank
closings in France, Germany and England which has left investors
shell-shocked; triggering capital flight from American markets
and supplanting confidence in the US financial system with growing
suspicion and rage. Where are the regulators?
to Bloomberg News, "European and Asian investors will avoid most
US mortgage-backed securities for years without guarantees from
government-linked entities creating an enormous drag on the US
housing market." Foreign investors believe they were hoodwinked
by bonds that were deliberately mis-rated to maximize profits
for the investment banks. This may explain why $882 billion has
been diverted into Chinese and Indian stock markets in the last
losers of all, however, are the financial giants that created
most of the abstruse, debt-instruments that are now devouring
the system from within. The productive and "wealth creating" components
of the economy have been subordinated to a finance-driven model
which suddenly derailed due to the abusive expansion of debt.
Inevitably, some of the banks that took the greatest risks will
be shuttered and trillions of dollars in market capitalization
will disappear. They are the victims of their own scam.
it possible that anyone with a pulse and a minimal ability to
reason couldn't see the inherent problems of building a humongous
financial edifice on the prospect that millions of first-time
homeowners with "a bad credit history and no collateral" would
pay off there mortgages in a timely and responsible manner?
It is not possible. It was completely crazy... and foreseeable!
The real reason that the subprime swindle mushroomed into a humongous
economy-busting monster is that the markets are no longer policed
by any agency that believes in intervention. The pervasive "free
market" ideology rejects the notion of supervision or oversight
and, as a result, the markets have become increasingly opaque
and unresponsive to rules that may assure their continued credibility
or even their ability to function properly.
side" avatars of deregulation have transformed the world's most
vital and prosperous markets into a huckster's street-corner shell-game.
All regulatory accountability has vanished along with trillions
of dollars in foreign investment. What's left is a flea-market
for dodgy loans, dubious over-leveraged equities and "securitized"
Triple A-rated garbage.
it for the Reagan Revolution.
striking is how the new "structured finance" paradigm replicates
a political system which is no longer guided by principle or integrity.
It is not coincidental that the same flag that flies over Guantanamo
and Abu Ghraib flutters over Wall Street as well. Nor is it accidental
that the same system that peddles bogus, subprime tripe to gullible
investors also elevates a "waterboarding advocate" to the highest
position in the Justice Department. Both phenomena emerge from
the same fetid moral swamp - Bush's America.
Mike Whitney is a well respected freelance writer living in Washington
state, interested in politics and economics from a libertarian
perspective. He can be reached at [email protected].
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