goofed. When Fed chairman Ben Bernanke cut interest rates to 3
per cent January 30, 2008, the price of a new mortgage went
up. How does that help the flagging housing industry?
hour after Bernanke made the announcement that the Fed Funds rate
would be cut by 50 basis points, the yield on the 30-year Treasury
nudged up a tenth of a per cent to 4.42 per cent. The same thing
happened to the 10-year Treasury which surged from a low of 3.28
per cent to 3.73 per cent in less than a week. That means that
mortgages which are priced off long-term government bonds - will
be going up, too.
Is that what Bernanke
had in mind; to stick another dagger into the already-moribund
real estate market?
The Fed sets
short-term interest rates (The Fed Funds rate) but long-term rates
are market-driven. So, when investors see slow growth and inflationary
pressures building up; long-term rates start to rise. That's bad
news for the housing market.
the shocker: Bernanke KNEW that the price of a mortgage would
increase if he slashed rates, but went ahead anyway.
How did he
days ago, when he cut rates by 75 basis points, the 10-year
didn't budge from its perch at 3.64 per cent. It just shrugged
it off as meaningless. But a couple days later, when Congress
passed Bush's US$150 BILLION "Stimulus Giveaway", the 10-year
spiked with a vengeance - up 20 basis points on the day. In
other words, the bond market doesn't like inflation-generating
only reserves [banks] have is capital they borrowed from
why did Bernanke cut rates when he knew it would just add to the
say that he just wanted to throw a lifeline to his fat-cat investor
buddies on Wall Street by providing more liquidity for the markets. But
that's not it at all. The fact is, Bernanke had no choice.
He's facing a challenge so huge and potentially catastrophic;
that cutting rates must have seemed like the only option
he had. Just look at these graphs and you'll see what Bernanke
saw before he decided to cut interest rates. [http://benbittrolff.blogspot.com/2008/01/really-scary-fed-charts-why-bernanke.html]
on the charts for a better view.
graph (Total borrowings of Depository Institutions from the Federal
Reserve) shows that the banks are capital impaired and borrowing
at a rate unprecedented in history.
graph (Non borrowed reserves from Depository Institutions) shows
that the capital that the banks do have is quickly being depleted.
graph (Net Free or borrowed reserves of Depository Institutions)
is best summed up by econo-blogger Mike Shedlock who says: "Banks
in aggregate have now burnt through all of their capital and are
forced to borrow reserves from the Fed in order to keep lending.
Total reserves for two weeks ending January 16 are $39.98 billion.
Inquiring minds are no doubt wondering where $40 billion came
from. The answer is the Fed's Term Auction Facility." (Mish's
Global Economic Trend Analysis; http://globaleconomicanalysis.blogspot.com/)
So the only reserves they have is capital
they borrowed from the Fed.
fourth Fed graph illustrates the steep trajectory of the ever-expanding
money supply. (Monetary base)
careful review of these graphs should convince even the most hardened
skeptic that the banking system is basically underwater and insolvent.
We are entering uncharted waters. The sudden and shocking
depletion of bank reserves is due to the huge losses inflicted
by the meltdown in subprime loans and other similar structured
When US homeowners
default on their mortgages en-mass, they destroy money faster
than the Fed can replace it through normal channels. The result
is a liquidity crisis which deflates asset prices and reduces
monetized wealth, says economist Henry Liu.
process is in a state of collapse. The market for structured investments
- MBSs, CDOs, and Commercial Paper - has evaporated leaving the
banks with astronomical losses. They are incapable of rolling
over their short-term debt or finding new revenue streams to buoy
them through the hard times ahead. As the foreclosure-avalanche
intensifies; bank collateral continues to be down-graded which
is likely to trigger a wave of bank failures.
Liu sums it up like this: "Proposed government plans to bail out
distressed home owners can slow down the destruction of money,
but it would shift the destruction of money as expressed by falling
home prices to the destruction of wealth through inflation masking
falling home value." (The Road to Hyperinflation, Henry Liu, Asia
Times) It's a vicious cycle. The Fed is caught between the dual
millstones of hyperinflation and mass defaults. There's no way
which money is currently being destroyed will greatly accelerate
as trillions of dollars in derivatives are consumed in the flames
of a falling market. As GDP shrinks from diminishing liquidity,
the Fed will have to create more credit and the government will
have to provide more fiscal stimulus. But in a deflationary environment;
public attitudes towards spending quickly change and the pool
of worthy loan applicants dries up.
Even at 0 per cent interest rates, Bernanke will be stymied by
the unwillingness of under-capitalized banks to lend or over-extended
consumers to borrow. He'll be frustrated in his effort to restart
the sluggish consumer economy or stop the downward spiral. In
fact, the slowdown has already begun and the trend is probably
careful review of these graphs should convince even the
most hardened skeptic that the banking system is basically
underwater and insolvent.
financial markets are deteriorating at a faster pace than anyone
could have imagined. Mega-billion dollar private equity deals have
either been shelved or are unable to refinance. Asset-backed Commercial
Paper (short-term notes backed by sketchy mortgage-backed collateral)
has shrunk by $400 billion (one-third) since August. Also, the
market for corporate bonds has fallen off a cliff in a matter
of months. According to the Wall Street Journal, a paltry $850
million in high-yield debt has been issued for January, while
in January 2007 that figure was $8.5 billion - ten times bigger.
That's a hefty loss of revenue for the banks. How will they
make it up?
the Fed's graphs; they won't!
rate cuts sent stocks climbing on Wall Street on January 30, but
by early afternoon the rally fizzled on news that Financial Guaranty,
one of the nation's biggest bond insurers, would be downgraded.
The Dow lost 37 points by the closing bell.
of other major bond insurers, MBIA and Ambac, could be known as
early as January 31, but it is reasonable to expect that they
will lose their Triple A rating. According to Bloomberg:
the world's largest bond insurer, posted its biggest-ever quarterly
loss and said it is considering new ways to raise capital after
a slump in the value of subprime-mortgage securities the company
guarantee. The insurer lost $2.3 billion in the fourth-quarter.
Its downgrading from AAA will cripple its business and throw ratings
on $652 billion of debt into doubt. Many of the investment banks
have assets that will get a haircut."
The New York
State Insurance Department tried to work out a bailout plan but
the banks could not agree on the terms (Ed note: "They don't have
guarantee $2.4 trillion of debt combined and are sitting on losses
of as much as $41 billion, according to JPMorgan Chase & Co.
analysts. Their downgrades could force banks to write down $70
billion, Oppenheimer & Co. analyst Meredith Whitney said yesterday
in a report. (Bloomberg)
Fed is caught between the dual millstones of hyperinflation
and mass defaults. There's no way out.
bond insurers were working the same scam as the investment
banks. They found a loophole in the law that allowed them
to deal in the risky world of derivatives; and they dove in headfirst.
They set up shell companies called transformers (the same way
the investment banks established SIVs; Structured Investment Vehicles),
which they used as off balance sheets operations where
they sold "credit default swaps, which are derivative instruments
where one party, for a fee, assumes the risk that a bond or loan
will go bad. (The Bond Transformers, Wall Street Journal.) The
bond insurers have written about $100 billion of these swaps in
the last few years. Now they're all blowing up at once.
swaps (CDS) have turned out to be a goldmine for the bond
insurers and they've given a boost to the banks too, by freeing
up capital to use in other ventures. The banks profited on the
interest rate difference between the CDOs (collateralized debt
obligations) they bought and the payments they made to transformers...
The banks sometimes booked profits UPFRONT on the streams of income
they expected to receive. (WSJ)
eh? Who wouldn't want to enjoy the profit from a job before they've
done a lick of work?
that the whole swindle is beginning to unravel - and
tens of billions of dollars are headed for the shredder
- industry spokesmen still praise credit default swaps as financial
innovation. Go figure?
STILL GETTING THEIR MARCHING ORDERS FROM WALL STREET
of Europe's four largest economies (England, France, Germany,
Italy) held a meeting this week where they discussed better
ways to monitor the world's markets and banks. They did not,
however, push to create a new regime of oversight, regulation
and punitive action that would be directed at financial fraudsters
and their structured Ponzi-scams.
Politicians love to talk about greater transparency and watchdog
agencies, but they have no stomach for establishing the hard-fast
rules and independent policing organizations that are required
to keep the carpetbaggers and financial hucksters from duping
gullible investors out of their life savings. That is simply beyond
And that is why even now - when the world is facing the most
serious financial crisis since the Great Depression - corporate
toadies like British Prime Minister Gordon Brown merely reiterate
the script prepared for them by their boardroom-paymasters:
agencies don't reform themselves, the Europeans would turn to
regulatory response to enforce change."
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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