do not cease to exist because they are ignored".
- Aldous Huxley
credit storm, which began in July when two Bear Stearns hedge
funds were forced to liquidate, has continued to intensify and
roil the markets. Last week the noose tightened around auction-rate
securities,a little-known part of the market that requires short-term
funding to set rates for long-term municipal bonds.
The US$330 billion ARS market has dried up overnight pushing
up rates as high as 20 per cent on some bonds - a new benchmark
for short term debt. Auction-rate securities are now headed for
extinction just like the other previously-vital parts of the structured
finance paradigm. The $2 trillion market for collateralized debt
obligations (CDOs), the multi-trillion dollar mortgage-backed
securities market (MBSs) and the $1.3 asset-backed commercial
paper (ABCP) market have all shut down draining a small ocean
of capital from the financial system and pushing many of the banks
and hedge funds closer to default.
of insuring corporate bonds has skyrocketed in the last few weeks
making it more difficult for businesses to get the funding they
need to expand or continue present operations.
Much of this has to do with the growing uncertainty about the
reliability of credit default swaps, a $45 trillion dollar market
which remains virtually unregulated. Credit-default swaps are
a type of financial instrument that are used to speculate on a
company's ability to repay debt. They pay the buyer face value
in exchange for the underlying securities or the cash equivalent
if a borrower fails to adhere to its debt agreements.
When the price of CDSs increases, it means that there is greater
doubt about the quality of the bond. Prices are presently soaring
because the entire structured finance market - and anything connected
to it - is under withering attack from the meltdown in subprime
mortgages. As foreclosures continue to rise, the securities that
were fashioned from subprime loans will continue to unwind destroying
trillions of dollars of virtual-capital in the secondary market.
year ago US$20 million would have gotten Luminent Mortgage
Capital Inc. access to $640 million in loans to buy top-rated
mortgage-backed securities. Now that much cash gets the
firm no more than $80 million... (Only) six lenders are
offering five times leverage, while a year ago, 20 banks
extended 33 times."
all sounds more complicated than it really is. Imagine a 200 ft.
conveyor belt with two burly workers and a mountain-sized pile
of money on one end, and a towering bonfire on the other. Every
time a home goes into foreclosure; the two workers stack the money
that was lost on the transaction - plus all of the cash that was
leveraged on the home via "securitization" and derivatives - onto
the conveyor-belt where it is fed into the fire.
That is precisely what is happening right
now and the amount of capital that is being consumed by the flames
far exceeds the Fed's paltry increases to the money supply or
Bush's projected $168 billion "surplus package". Capital is being
sucked out of the system faster than it can be replaced which
is apparent by the sudden cramping in the financial system and
a more generalized slowdown in consumer spending.
to a recent Bloomberg article:
year ago $20 million would have gotten Luminent Mortgage Capital
Inc. access to $640 million in loans to buy top-rated mortgage-backed
securities. Now that much cash gets the firm no more than $80
million... (Only) six lenders are offering five times leverage,
while a year ago, 20 banks extended 33 times."
banks are not providing anywhere near as much money for leveraged
investments as they did just last year. And, when credit shrinks
on a national scale - as it is - so does the economy. It' a simple
formula; less money means less economic activity, less growth,
fewer jobs, tighter budgets, more pain.
Street firms, reeling from $146 billion in losses on their debt
holdings, are fueling a credit crisis by clamping down on lending
to investors and hedge funds that use borrowed money to buy securities.
By pulling back, (the banks) are contributing to reduced demand
and lower prices throughout the fixed-income world."
is no chance that the economy will rebound until housing
prices stabilize and the rate of foreclosures returns to
normal. But that could be a long way off. With housing inventory
at historic highs and mortgage applications at new lows,
the economy could keep somersaulting down the
stairwell for a full two years or more.
are in no position to be extravagant because they're already saddled
with $400 billion in MBSs and CDOs - as well as another $170 billion
in private equity deals - for which there is currently no market.
They've had to dramatically cut back on their lending because
they either don't have the resources or are facing bankruptcy
in the near future.
which appeared on the front page of the Financial Times last week,
illustrates how hard-pressed the banks really are:
have been quietly borrowing massive amounts of money from the
Federal Reserve... $50 billion in one month".
new Term Auction Facility "allows the banks to borrow money against
all sorts of dodgy collateral," says Christopher Wood, analyst
at CLSA. "The banks are increasingly giving the Fed the garbage
collateral nobody else wants to take... [this] suggests a perilous
condition for America's banking system."
has sparked unease among some analysts about the stress developing
in opaque corners of the US banking system and the banks' growing
reliance on indirect forms of government support." ("US Banks
borrow $50 billion via New Fed Facility", Financial Times)
appeared no where in the US media.)
At the same
time the banks are getting backdoor injections of liquidity from
the Fed; banking giant Citigroup has been trying to off-load some
of its branches so it can cover its structured investment losses.
It all looks rather desperate, but scouring the planet for capital
to shore up flagging balance sheets is turning out to be a full-time
job for many of America's largest investment banks. It is the
only way they can stay one step ahead of the hangman.
of the banks are technically insolvent already, hopelessly
mired in their own red ink... The system is self-destructing.
the last few days, gold has spiked to $950, a new high, while
oil futures passed the $100 per barrel mark. The battered greenback
has already taken a beating, and yet, Fed chairman Ben Bernanke
is signaling that there are more rate cuts to come. The prospect
of a global run on the dollar has never been greater. Still, Bernanke
will do whatever he can to resuscitate the faltering banking system,
even if he destroys the currency in the process.
Unfortunately, interest rates alone won't
cut it. The banks need capital; and fast. Meanwhile, the waning
dollar has sent food and energy prices soaring which is leaving
consumers without the discretionary income they need for anything
beyond the basic necessities. As a result, retail sales are down
and employers are forced to lay off workers to reduce their spending.
This is all part of the self-reinforcing negative-feedback loop
that begins with falling home prices and then rumbles through
the broader economy. There is no chance that the economy will
rebound until housing prices stabilize and the rate of foreclosures
returns to normal. But that could be a long way off. With housing
inventory at historic highs and mortgage applications at new lows,
the economy could keep somersaulting down the stairwell
for a full two years or more. Only then, will we hit rock-bottom.
country is now headed into a deep and protracted recession. Low
interest credit and financial innovation have paralyzed the credit
markets while inflating a monstrous equity bubble that is wreaking
havoc with the world's financial system. The new market architecture,
"structured finance", has collapsed from the stress of falling
asset-values and rising defaults. Many of the banks are technically
insolvent already, hopelessly mired in their own red ink. Public
confidence in the nations' financial institutions has never been
lower. Monetary policy and deregulation have failed. The
system is self-destructing.
that the credit crunch has rendered the markets
dysfunctional, spokesmen for the investor class are speaking
out and confirming what many have suspected from the very beginning;
that the present troubles originated at the Federal Reserve and,
ultimately, they are the ones who are responsible for the meltdown.
Fed refused to perform its oversight duties because its
friends in the banking industry were raking in obscene profits
selling sketchy, subprime junk to gullible investors around
the world. They knew about the "massive off balance-sheet
positions" which allowed the banks' to create mortgage-backed
securities and CDOs without sufficient capital reserves.
They knew it all...
In an article
in the Wall Street Journal this week, Harvard economics professor
and former Council of Economic Advisers under President Reagan,
Martin Feldstein, made this revealing admission:
is plenty of blame to go around for the current situation. The
Federal Reserve bears much of the responsibility, because of its
failure to provide the appropriate supervisory oversight for the
major money center banks. The Fed's banking examiners have complete
access to all of the financial transactions of the banks that
they supervise, and should have the technical expertise to evaluate
the risks that those banks are taking. Because these banks provide
credit to the nonbank financial institutions, the Fed can also
indirectly examine what those other institutions are doing.
bank examinations are supposed to assess the adequacy of each
bank's capital and the quality of its assets. The Fed declared
that the banks had adequate capital because it gave far too little
weight to their massive off balance-sheet positions - the structured
investment vehicles (SIVs), conduits and credit line obligations
- that the banks have now been forced to bring onto their balance
sheets. Examiners also overstated the quality of the banks' assets,
failing to allow for the potential bursting of the house price
bubble. The implication of this for Fed supervision policy is
clear. The way out of the current crisis is not."
So, when all else fails; tell the truth?
Feldstein is right; the Fed refused to perform its oversight duties
because its friends in the banking industry were raking in obscene
profits selling sketchy, subprime junk to gullible investors around
the world. They knew about the "massive off balance-sheet positions"
which allowed the banks' to create mortgage-backed securities
and CDOs without sufficient capital reserves. They knew it all;
every last bit of it, which simply proves that the Federal Reserve
is an organization which serves the exclusive interests of the
banking establishment and their corporate brethren in the financial
global recession/depression will give us plenty of time to mull
over the ruinous effects of Fed policy and to devise a plan for
abolishing the Federal Reserve once and for all. That is, if they
don't destroy us first.
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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