In a recent
interview with the New York Times, former Secretary of the Treasury,
Paul O' Neill, was asked how the problems with subprime mortgages
could lead to a financial crisis of global proportions.
O' Neill said, "If
you have 10 bottles of water, and one bottle has poison in it,
and you don't know which one, you probably won't drink out of
any of the 10 bottles; that's basically what we've got here."
O' Neill's answer is the best yet for explaining a complex
situation in simple terms. The term "subprime" is a red herring;
it is used by the media to minimize what is really going on. The
meltdown in financing extends across the entire range of mortgage-security
products. No loan-type has been spared. The wholesale market for
anything connected to mortgages is frozen and the details
are being intentionally withheld from the public.
Two years ago, more than 65 per cent of
all mortgages were converted into securities and sold off to Wall
Street. No more. That scam unraveled in July when two Bear Stearns
hedge funds blew up and their were no takers for billions of dollars
of mortgage-backed junk. Since then, bankers and hedge fund managers
have been scrambling to conceal the facts about what mortgage-backed
securities (MBS) are really worth; nothing. The fear is that when
the public finds out what is really going on, they'll draw the
logical conclusion that the banking system is bankrupt, which
it probably is.
Just look at these eye-popping losses which appeared in Bloomberg
News on April 1. The financial ship is listing, and the mainstream
media is doing its best to keep the public in the
So for the
last eight months, a simple matter of "price discovery" on publicly
traded securities has been a nonstop game of hide-n-seek. That's
no way to run a free market. The recent collapses of Bear Stearns
and Carlye Capital are just the latest additions to this ongoing
and hedge fund managers have been scrambling to conceal
the facts about what mortgage-backed securities (MBS) are
really worth; nothing... The Fed thinks they can simply
put these MBSs in cold-storage for a while and then re-thaw
them when the market bounces back. But the market for MBSs
won't bounce back.
a US$22 billion hedge fund that couldn't scrape together a measly
$400 million to meet a margin call. Why? Every analyst who wrote
on the topic noted that the fund was loaded up with high-quality
Triple-A and GSE (Fannie Mae) bonds. So what were they offered
for their MBS?
That question was never answered because Fed chief Ben Bernanke
rode to the rescue and created a new $200 billion auction facility
and - whoosh - Carlyle's mortgage-backed junk disappeared down
a black hole. How convenient; another Fed bailout to hide the
damning evidence that trillions of dollars of MBSs are utterly
worthless and devouring the financial system from the inside.
myriad auction facilities (four, so far) are ostensibly designed
to remove these mortgage-backed stinkers from the banks' balance
sheets so they can start lending again. But there's another reason,
too. The Fed thinks they can simply put these MBSs in cold-storage
for a while and then re-thaw them when the market bounces back.
But the market for MBSs won't bounce back.
This is biggest housing bust in US history and prices have a long
way to go. Who is going to invest in mortgage-backed bonds when
the underlying asset is losing value every day? Besides,
as Paul O' Neill points out; one of the bottles contains poison
and investors don't like poison. So, Bernanke is stuck trying
to treat with the symptoms rather than the disease.
As a scholar of the Great Depression, he's been rifling through
his bag o' tricks to mitigate the damage, but without success.
The rate-cuts and auction facilities have been a complete flop.
The situation is worse now than it was in July; much worse. In
fact, the de-leveraging of financial institutions is accelerating
at a pace that no one expected threatening some of Wall Streets'
biggest players and putting $500 trillion in counterparty agreements
And it all began with eliminating the basic standards for
issuing loans to credit-worthy applicants; the straw that broke
the camel's back. Now the whole system is crumbling and an
ominous sense of doom pervades trading floors across the planet. Everyone
is just waiting for the next shoe to drop.
the Fed and the Secretary of the Treasury, Henry Paulson,
are pushing to expand Fannie's and Freddie's balance
sheets so they can absorb bigger and riskier mortgages.
This is lunacy.
Bill Gross said, "What we are seeing is the collapse of the modern
day banking system." American-style capitalism is in crisis-mode
and the outcome is far from certain. The Fed's interventions show
that the long held belief that markets are self-correcting has
vanished. Laissez-faire is out; regulation is in.
News summed it up like this:
no coincidence that the crisis of 2007 and 2008 had its origin
in unregulated financial products traded in unregulated markets.
Ever since the Great Depression, the government has tried to limit
the leverage available to the public in the American stock market.
But regulators, led by Alan Greenspan, the former chairman of
the Federal Reserve, thought it would hamper innovation, and drive
financial activity overseas, if there were any attempts to impose
limits on leverage in the unregulated markets.
a super-bubble in the future, (the) banks must control their own
borrowing. They must also curtail lending to clients such as hedge
funds by demanding greater collateral and margin requirements
on loans." (Bloomberg News)
Liu's latest article in Asia Times, "A Panic-stricken Federal
Reserve", Liu makes this observation on the Fed's auction facilities
which provide hundreds of billions of dollars in 28-day loans
in exchange for dubious mortgage-backed collateral:
the Fed cannot retire loans made via TAF and its repo program
without adding to those 'elevated pressures', the loans should
be considered an equity infusion, because they'll be repaid at
the convenience of the borrower rather than on a schedule agreed
with the lender." What Waldman did not say was that the Fed had
ventured into a broad nationalization of the prime dealers on
Wall Street by being an equity investor. (Quote, Steve Randy
Waldman of Interfluidity; Henry Liu, "A Panic-stricken Federal
the Fed realize that it is effectively monetizing the debt by
issuing loans that may not be repaid or is this just a clever
way to trick foreign investors into believing that the Fed won't
print its way out of a crisis? The bottom line is, whether the
nation is headed into a deflationary spiral or not; all of the
Fed's tools are inflationary. Rate cuts, auction facilities or
covert monetization all weaken the currency and levee an unfair
tax on savers and people on fixed incomes. Unfortunately, these
people have no voice in government, so we can't expect their interests
to be fairly represented."
myth that "housing prices never go down" has been dispelled
and high levels of personal debt have forced many
to reassess their spending priorities. The American
consumer has never been so over-extended.
peaked in 2005, 240 independently-owned mortgage lenders have
filed for bankruptcy. Wholesale funding sources have dried up
and foreclosures are on the rise. Now, more than 75 per cent of
mortgages are funded by Fannie Mae or Freddie Mac while another
10 per cent are underwritten by the FHA.
The real estate industry has been nationalized; another knock-on
effect of Greenspan's low interest monetary policy.
Presently, the Fed and the Secretary of the Treasury, Henry Paulson,
are pushing to expand Fannie's and Freddie's balance
sheets so they can absorb bigger and riskier mortgages. This is
lunacy. Fannie Mae is already perilously under-capitalized and,
if it defaults, taxpayers will be on the hook for $2.2 trillion.
That doesn't seem to bother Paulson who is determined to reflate
the equity bubble so the profits keep rolling in to Wall
Still, even if the plan goes forward, it's unlikely that
Paulson and Bernanke will be able to re-energize the real
estate market or ignite another housing boom. Public attitudes
have changed dramatically in the last few months. The myth that
"housing prices never go down" has been dispelled and high levels
of personal debt have forced many to reassess their spending
priorities. The American consumer has never been so over-extended.
fell behind on car, credit-card and home-equity loans at the highest
level in 15 years, another sign the U.S. economy is slowing, according
to the American Bankers Association's quarterly survey. Payments
at least 30 days past due increased across all eight categories
of loans tracked during the fourth quarter, the Washington-based
group said today in a statement. Late loans in the quarter climbed
21 basis points to 2.65 per cent of all accounts in a consumer-loan
index created by the group."
consumer is tapped-out. What he needs is a raise, not another
loan. Bush's $500 per person Stimulus Package will do nothing
to reverse the effects of 30 years of anti-labor legislation and
class-oriented monetary policy.
indication that attitudes towards spending have changed, showed
up in a survey conducted two weeks ago by USA Today/Gallup. The
poll released showed that 76 per cent of Americans believe that
the country is now in recession and 59 per cent think the US will
slide into a depression that will last for several years. Despite
the media's attempts to convince us that these are "the best of
times"; the public knows otherwise. Their pessimism is expressing
itself through curtailed spending. There's nothing the Fed can
do to change the prevailing mood of the country. Working people
are hurting. The spending spree is over.
the media's attempts to convince us that these are "the
best of times"; the public knows otherwise. Their pessimism
is expressing itself through curtailed spending.
housing market will be dead for a generation. That means the MBS
market will falter and the multi-trillion dollar derivatives monolith
will continue to unwind. It will take emergency measures to address
the credit avalanche which is just now hitting the broader economy.
Bear Stearns bailout is a prime example of the extent to
which the Fed is willing to go to stop a meltdown. By approving
the $30 billion dollar deal with JP Morgan, the Fed arbitrarily
went beyond its mandate of providing liquidity to the markets
and usurped Congress' authority to appropriate funds. It was a
power-grab engineered under shaky pretenses. The Fed isn't authorized
to prevent privately-owned businesses that are recklessly leveraged
at 30 to 1 from defaulting. More importantly, the Federal Reserve
is not Congress, although they have now assumed those constitutional duties.
Speaker of the House Pelosi has said nothing so far.
used the Bear fiasco as a platform for his blueprint for
"broad market reforms"; a 200-plus page document that removes
Congress from its role of overseeing the financial markets. According
to the New York Times:
Bush was preparing to issue an executive order soon to expand
the membership and reach of an interagency committee called the
President's Working Group on Financial Markets. (aka; The Plunge
Protection Team) The group was created after the stock market
plummeted in 1987. The group is also expected to consider ways
to broaden the authority of the Federal Reserve to lend money
to nonbanks as needs arise. (Ed. note: To authorize more Bear
Stearns type bailouts without consulting Congress)... Elements
of the plan are clearly deregulatory. The plan proposes, for instance,
to reduce the enforcement authority of the S.E.C. in a variety
of ways and hand that authority instead to industry groups. The
plan recommends that investment advisers no longer be directly
regulated by the commission, but instead be supervised by an industry
Department's blueprint is designed to boost Wall Street's competitiveness,
not Main Street investor protection," said Karen Tyler, president
of the North American Securities Administrators Association and
the securities commissioner of North Dakota." (New York Times)
is being muscled out of financial market supervision
by a troop of venal banksters and corporate picaroons who
are threatening to finish off the already-defanged SEC. That will
put the Fed in the driver's seat for good. Paulson wants to police
the world's most complex markets on the "honor system". It's crazy.
His blueprint is an obvious attempt to consolidate market-related
functions under a central authority that is accountable to private
industry alone. That way, the Fed can bail out whomever it chooses
without congressional approval. Paulson's press conference was
just a polite way of informing the American people that the seat
of power has shifted from Washington to Wall Street. It's a banker's
wants to police the world's most complex markets on the
"honor system". It's crazy. His blueprint is an obvious attempt
to consolidate market-related functions under a central
authority that is accountable to private industry alone.
where do we go from here? Pimco's Bill Gross gives us some indication
in this recent quote:
opinion, the private credit markets have forfeited their privileged
right to operate relatively autonomously because of incompetence,
excessive greed, and, in minor instances, fraudulent activities.
As a result, the deflating private market's balance sheet is being
re-nationalized in some cases with increased regulation, in others
with outright guarantees and agency lending. Ultimately government
programs which support private credit market assets may be required
in order to prevent an asset deflation of significant proportions.
Authorities must act quickly, with a shot of adrenalin straight
to the heart of the problem: home prices. Since homes are the
most highly levered and monetarily significant asset that American
consumers own, if they decline much further they will drag the
rest of the economy with them."
is that what it is? No one authorized the Fed or Paulson to re-nationalize
anything. These over-leveraged banking behemoths need to fail.
Let the market work. 28 million Americans are on food stamps,
tent cities are sprouting up across the country, discretionary
spending is down, food and energy prices are skyrocketing, and
wages have been frozen for a generation. Where's the bailout for
the working man? Instead, the government's largess is showered
on a throng of unctuous fat-cat banksters so they can keep
the larder on Martha's Vineyard topped off with Godiva truffles
and Cuban cigars. Paulson has to go. Bernanke too.
in last week's New York Times, "Leveraged Planet", provides
a great description of the Fed's activities during the weekend
of the Bear Stearns fiasco. Journalist Andrew Sorkin recreates
the frantic phone calls and panicky deal-making that went on behind
the scenes while the stock market was preparing for a Monday morning
before JP Morgan-Chase announced its initial $2-a-share deal
to buy Bear Stearns, Ben Bernanke, the chairman of the Federal
Reserve, held an extraordinary impromptu conference call. The
participants on the Sunday night call, who got a preview of the
deal, were Wall Street's biggest power brokers: Lloyd Blankfein
of Goldman Sachs dialed in from home. John Mack of Morgan Stanley
rushed to the office to listen on speakerphone. Richard Fuld of
Lehmann Brothers, who had been directed to return home from a
business trip in New Delhi by none other than Henry Paulson, the
Treasury secretary, was patched in, too, among others.
call was a rallying cry for support of Bear Stearns - and more
broadly, the financial markets, which, as it was described on
the call, were on the verge of a major meltdown if not for the
pre-emptive steps that the Fed and JP Morgan took. "It was much
worse than anyone realized; the markets were on the precipice
of a real crisis," said one participant. Given that Bear held
trading contracts with an outstanding value of $2.5 trillion with
firms around the world, "we were talking about the possibility
of a global run on the bank." (Andrew Sorkin, "Leveraged Planet"
New York Times)
the Times, the reader is left feeling that the wild and destabilizing
activities of one unregulated market participant, like Bear, is
as natural as a spring rain. There's not the slightest hint that
Bears' transgressions may have emerged from years of kicking down
regulatory doors and feeding campaign contributions into a corrupt
political system. That's way beyond the Times' range of analysis.
Instead, the heroes of this financial kabuki are none other than
the ashen-faced palatines at Fed and the Treasury who deftly donned
their Haz-mat suits long enough to battle the flames of the banking
inferno with a stream of taxpayer money.
So much for moral hazard.
Bear had been properly policed; it would have been better capitalized
with considerably less leverage. Its $2.5 trillion of derivatives
contracts would have been regulated by government officials to
make sure that they posed no threat to the broader system. Sorkin's
recap just proves that the present stewards of the system are bunglers
who are out of their depth. After years of serial bubble-making,
they are finally begin to realize that their neoliberal Golden
Calf was built on a foundation of pure quicksand.
Bear had been properly policed; it would have been better
capitalized with considerably less leverage. Its $2.5 trillion
of derivatives contracts would have been regulated by government
officials to make sure that they posed no threat to the
the sirens are already wailing as the yields on three-month Treasuries
continue to plummet, which is the bond market's way of perching
itself atop the highest building in downtown Manhattan and screaming,
"FIRE!" There's no telling when the stock market will get the
message, but it shouldn't be too long.
Emergency planning now underway.
is to be done? New York Fed chief Timothy Geithner says that capital
markets are still "substantially impaired" and policy makers and
financial industry leaders must "act forcefully" to stem the crisis.
we were observing in U.S. and global financial markets was similar
to the classic pattern in financial crises,'' Geithner said in
his prepared testimony to the Senate Banking Committee. He cited
"a self-reinforcing downward spiral'' of asset sales, "higher
volatility, and still lower prices." (Bloomberg News)
predictions of "a self-reinforcing downward spiral'' sound scary;
so do the remedies. The Financial Times outlined the radical strategies
that are now under consideration by the G-7 powers for dealing
with challenges of the rapidly-expanding credit crisis. These
include "the temporary suspension of capital requirements, taxpayer-funded
recapitalisation of banks and outright public purchase of mortgage-backed
securities." Everything is on the table.
from the main western central banks are also discussing whether
to force a number of the larger banks to disclose their financial
positions so they can objectively determine the weaknesses on
their balance sheets.
include boosting capital requirements, "conserving financial resources",
and utilizing public funds. The group is also deciding whether
to "suspend capital and reporting rules that tie prudential requirements
to market values of securities." That way the banks can avoid
letting shareholders know the true downgraded value of their assets.
This is clearly an attempt to deceive the public about the real
financial condition of the banks.
liquidity support", reductions in capital requirements, concealing
the true value of collateral, relaxing regulations, suspending
accounting rules for assets; it sounds a lot like panic. These
are the signs of a system so dilapidated that the pilings shake
and the scaffolding wobbles with the slightest breeze. A system
that's held together with the frayed strands of collective fear;
bankers angst. Strike a match and the whole thing will go up like
a Roman candle.
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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