saw a picture Bernanke stripped to the waist in the boiler-room
shoveling greenbacks into the furnace."
- Rob Dawg, Calculated Risk blog-site
January 14, 2008 the FDIC website began posting the rules for
reimbursing depositors in the event of a bank failure. The Federal
Deposit Insurance Corporation (FDIC) is required to "determine
the total insured amount for each depositor... as of the day of
the failure" and return their money as quickly as possible. The
agency is "modernizing its current business processes and procedures
for determining deposit insurance coverage in the event of a failure
of one of the largest insured depository institutions."
is clear, the FDIC has begun the "death watch" on the many banks
which are currently drowning in their own red ink. The problem
for the FDIC is that it has never supervised a bank failure which
exceeded 175,000 accounts. So the impending financial tsunami
is likely to be a crash-course in crisis management. Today, some
of the larger banks have more than 50 million depositors, which
will make the FDIC's job nearly impossible.
worth noting that, due to a rule change by Congress in 1991, the
FDIC is now required to use "the least costly transaction when
dealing with a troubled bank. The FDIC won't reimburse uninsured
depositors if it means increasing the loss to the deposit insurance
fund... As a result, uninsured depositors are protected only if
a bank acquiring the failed bank will pay more for all of the
deposits than it would for insured deposits only." (MarketWatch)
That's reassuring. And there's more, too. FDIC Chairman Sheila
Bair warned that "as of Sept. 30, there were 65 institutions with
assets of US$18.5 billion on its list of "problem" institutions;"
although she wouldn't give names.
what does it all mean?
means there's going to be an unprecedented wave of bank closures
in the US and that people who want to hold on to their life savings
are going have to be extra vigilant as the situation continues
to deteriorate. And it is deteriorating very quickly.
now, many of the country's largest investment banks are holding
$500 billion in mortgage-backed securities and other structured
investments that are steadily depreciating in value. As these
assets wear away the banks' capital, the likelihood of default
January 14, 2008 the Federal Deposit Insurance Corporation
began posting the rules for reimbursing depositors in the
event of a bank failure.
Fitch Ratings announced that it will (probably) cut ratings on
the five main bond insurers (Ambac, MBIA, FGIC, CIFG, SCA) "regardless
of their capital levels". This seemingly innocuous statement has
roiled markets and put Wall Street in a panic. If the bond insurers
lose their AAA rating (on an estimated $2.4 trillion of bonds)
then the banks could lose another $70 billion in downgraded assets.
That would increase their losses from the credit crunch - which
began in August 2007 - to $200 billion with no end in sight.
It would also impair their ability to issue loans to even credit
worthy customers which will further dampen growth in the larger
economy. Structured investments have been the banks' "cash cow"
for nearly a decade, but, suddenly, the trend has shifted into
reverse. Revenue streams have dried up and capital is being destroyed
at an accelerating pace. The $2 trillion market for collateralized
debt obligations (CDOs) is virtually frozen leaving horrendous
debts that will have to be written-down leaving the banks' either
deeply scarred or insolvent. It's a mess.
were some interesting developments in a case involving Merrill
Lynch the previous week which sheds a bit of light on the true
"market value" of these complex debt-pools called CDOs. The Massachusetts
Secretary of State has charged Merrill with "fraud and misrepresentation"
for selling them a CDO that was "highly risky and esoteric" and
"unsuitable for the City of Springfield." (Most cities are required
by law to only purchase Triple A rated bonds.) The city of Springfield
bought the CDO less than a year ago for $13.9 million. It is presently
valued at $1.2 million - MORE THAN A 90 per cent LOSS IN LESS
THAN A YEAR.
has quietly settled out of court for the full amount and seems
genuinely confused by the Massachusetts Secretary of State's apparent
anger. A Merrill spokesman said blandly, "We are puzzled by this
suit. We have been cooperating with the Secretary of State Galvin's
office throughout this inquiry."
it really that hard to understand why people don't like getting
going to be an unprecedented wave of bank closures in the
US and that people who want to hold on to their life savings
are going have to be extra vigilant as the situation continues
shows that these exotic mortgage-backed securities are real stinkers.
They're worthless. The market for structured debt-instruments
has evaporated overnight leaving a massive hole in the banks'
balance sheets. The likely outcome will be a rash of defaults
followed by greater consolidation of the major players (re: banking
monopolies). The Fed's multi-billion bailout plan, the "Temporary
Auction Facility" (TAF), is a quick-fix, but not a permanent solution.
The real problem is insolvency, not liquidity.
banks are in dire straits, too. They're bogged down with commercial
and residential loans that are defaulting faster than at any time
since the Great Depression. The Comptroller of the Currency, John
Dugan - who is presently investigating commercial real estate
loans - discovered that commercial banks "wrote off $524 million
in construction and development loans in the third quarter of
2007, almost nine times the amount of 2006". The commercial real
estate market is following residential real estate off a cliff
and will undoubtedly be the next shoe to drop.
out that, "More than 60 per cent of Florida banks have commercial
real estate loans worth more than 300 per cent of their capital,
a level that automatically attracts more attention from examiners."
(Wall Street Journal)
He said that his office was prepared to intervene if banks with
large real estate exposure maintained unreasonably low reserves
for bad loans. Dugan is forecasting a steep "increase in bank
to Reuters: "Dozens of US banks will fail in the next two
years as losses from soured loans mount and regulators crack down
on lenders that take too much risk, especially in real estate
and construction," predicts Gerard Cassidy, RBC Capital Markets
analyst. Apart from the growing losses in commercial and
residential real estate, the banks are carrying over $150 billion
of "un-syndicated" debt connected to leveraged buyout deals (LBOs)
which are presently stuck in the mud. Like CDOs, there's no market
for these sketchy transactions which require billions in
cheap, easily available credit. They've just become another
anvil dragging the banks under.
city of Springfield bought the CDO (collateralized debt
obligation) less than a year ago for US$13.9 million [from
Merrill Lynch]. It is presently valued at $1.2 million -
MORE THAN A 90 per cent LOSS IN LESS THAN A YEAR. Merrill
has quietly settled out of court for the full amount.
31, Bloomberg News reported: "Losses from securities linked to
subprime mortgages may exceed $265 billion as regional U.S. banks,
credit unions and overseas financial institutions write down the
value of their holdings." Standard and Poor's added that "it may
cut or reduce ratings of $534 billion of subprime-mortgage securities
and CDOs as default rates rise." Another blow to the banks' withering
balance sheets. Is it any wonder why the "new loans" spigot has
been turned off?
there's an even bigger threat to the financial system than
these staggering losses at the banks. A default by one of the
big bond insurers could trigger a meltdown in the credit-default
swaps market, which could lead to the implosion of trillions of
dollars in derivatives bets. The inability of the under-capitalized
monolines (bond insurers) to "make good" on their coverage is
likely to set the first domino in motion by increasing the number
of downgrades on bond issues and intensifying the credit-paralysis
which already is spreading throughout the system.
financial analyst Jim Jubak summed it up like this: "Actually,
I'm worried not so much about the junk-bond market itself as the
huge market for a derivative called a credit default swap, or
CDS, built on top of that junk-bond market. Credit default swaps
are a kind of insurance against default, arranged between two
parties. One party, the seller, agrees to pay the face value of
the policy in case of a default by a specific company. The buyer
pays a premium, a fee, to the seller for that protection.
has grown to be a huge market: The total value of all CDS contracts
is something like $450 trillion... Some studies have put the real
credit risk at just 6 per cent of the total, or about $27 trillion.
That puts the CDS market at somewhere between two and six times
the size of the U.S. economy.
it will take in the CDS market is enough buyers and sellers deciding
they can't rely on this insurance anymore for junk-bond prices
to tumble and for companies to find it very expensive or impossible
to raise money in this market." (Jim Jubak's Journal; "The Next
Banking Crisis is on the Way", MSN Money)
really nails it here. In fact, this is what Wall Street is really
worried about. $450 trillion in cyber-credit has been created
through various off balance sheets operations which neither the
Fed nor any other regulatory body can control. No one even knows
how these abstruse, credit-inventions will perform in a falling
market. But, so far, it doesn't look good.
it will take in the CDS (credit default swap) market is
enough buyers and sellers deciding they can't rely on this
insurance anymore for junk-bond prices to tumble and for
companies to find it very expensive or impossible to raise
money in this market."
- Market analyst Jim Jubak
of the derivatives market ($450 trillion) is the direct result
of Alan Greenspan's easy-credit monetary policies as well as the
reconfiguring of the markets according to the "structured finance"
model. The new model allows banks to run off-balance sheets operations
that, in effect, create money out of thin air.
Similarly, "synthetic" securitization, in
the form of credit default swaps (CDS) has turned out to be another
scam to avoid maintaining sufficient capital to cover a sudden
rash of defaults. The bottom line is that the banks and non-bank
institutions wanted to maximize their profits by keeping all their
capital in play rather than maintaining the reserves they'd need
in the event of a market downturn.
a deregulated market, the Federal Reserve cannot control the creation
of credit by
non-bank institutions. As the massive derivatives bubble unwinds,
it is likely to have real and disastrous effects on the underlying
productive economy. That's why Jubak and many other market analysts
are so concerned. The persistent rise in home foreclosures means
that the derivatives which were levered on the original assets
(sometimes exceeding 25 times their value) will vanish down a
black hole. As trillions of dollars in virtual-capital are extinguished
by a click of the mouse; the prospects of a downward deflationary
spiral become more likely.
Nouriel Roubini said: "One has to realize that there is now a
rising probability of a 'catastrophic' financial and economic
outcome, i.e. a vicious circle where a deep recession makes the
financial losses more severe and where, in turn, large and growing
financial losses and a financial meltdown make the recession even
more severe. That is why the Fed has thrown caution to the wind
and taken a very aggressive approach to risk management." (Nouriel
"In the fourth
quarter of 2007, new foreclosures averaged 2,939 a day, double
the pace of a year earlier." (RealtyTrac Inc.) The banks are presently
cutting back on home equity loans which provided an additional
$600 billion to homeowners last year for personal consumption.
Bush's $150 billion "stimulus package" will barely cover a quarter
of the amount that is lost.
spending slows and the banks become more constrained
in their lending; businesses will face overproduction problems and
will have to limit their expansion and lay off workers. This is
the downside of "low interest" bubble-making; a painful descent
bottom line is that the banks and non-bank institutions
wanted to maximize their profits by keeping all their capital
in play rather than maintaining the reserves they'd need
in the event of a market downturn.
is now being destroyed at a faster pace than it is being created.
That's why the Fed is looking for solutions beyond mere rate cuts.
Federal Reserves chairman Ben Bernanke wants direct government
action that will provide immediate stimulus. But that takes political
consensus and there's still debate about the gravity of the upcoming
The pace of the economic contraction is breathtaking. Last week's
release of the Institute for Supply Management's Non-Manufacturing
Index (ISM) was a shocker. It showed steep declines in all areas
of the nation's service sector - including banks, travel companies,
contractors, retail stores, etc. The Business Activity Index,
the New Orders Index, the Employment Index and the Supplier Delivery
Index have all contracted at a "historic" pace.
took a hit.
are so terrible, it's beyond belief," said Scott Anderson, senior
economist at Wells Fargo & Co. The $2 trillion that has been
wiped out from falling home prices, the slowdown in lending activity
at the banks, the loss of $600 billion in home equity loans, and
the faltering stock market have all contributed to a noticeable
change in the public's attitudes towards spending.
Traffic to the shopping malls has slowed to a crawl. Retail shops
had their worst January on record. Homeowners are hoarding their
earnings to cover basic expenses and to make up for their lack
of personal savings. The spending-spigot has been turned off.
America's consumer culture is in full retreat. The slowdown is
here. It is now. We are likely to see the sharpest decline in
consumer spending in US history. Bush's $150 billion will be too
little too late.
place in the world has been guaranteed not by what it produces
but by what it consumes. The American consumer has been the locomotive
that drives the global economy. Now that engine has been derailed
by the reckless monetary policies of the Fed and by shortsighted
When equity bubbles collapse; everybody pays. Demand for goods
and services diminishes, unemployment soars, banks fold, and the
economy stalls. That's when governments have to step in
and provide programs and resources that keep people working and
sustain business activity. Otherwise there will be anarchy. Middle
class people are ill-suited for life under a freeway overpass.
They need a helping hand from government. Big government. Good-bye,
Reagan. Hello, F.D.R.
stimulus plan is a drop in the bucket. It'll take much, much more.
And, we're not holding our breath for a New Deal from George Walker
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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