Bernanke Joins G7 To
Stem Global Meltdown
By Mike Whitney
4-10-8
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."
Bulls-eye. 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
percent 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 <http://
www.bloomberg.com/apps/news?pid=3D20601208&sid=3Dan2o_RDeA.9A&refer=3Dfinanc=
e>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 dark.
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 farce. Carlyle was a $22 billion hedge fund that couldn't
scrape together a measly $400 billion 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 =ADWhoosh---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.
Bernanke's 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
develeraging 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 at risk. 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 drop.
Pimco's 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.
Bloomberg News summed it up like this:"It is 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.
To avoid 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)
In Henry 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:
"Since 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 Reserve")
Does 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.
Since housing 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 percent of mortgages
are funded by Fannie Mae or Freddie Mac while another 10 percent are
underwritten by 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 Street's coffers.
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 going 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.
According to Bloomberg: Consumers 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 percent of
all accounts in a consumer-loan index created by the group.
The American 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.
Another 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 percent of Americans believe that the
country is now in recession and 59 percent 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 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.
The 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.
Paulson has 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:
"President 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 with 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 regulatory organization.
The Treasury 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)
Congress 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 bailout 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 coup.
So, where do we go from here? Pimco's Bill Gross gives us some
indication in this recent quote: "In my 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 ."
"Re-nationalized"; 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.
An article 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 blow-out:
" JUST 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.
The half-hour 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 JPMorgan 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)
Typical of 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.
If 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. In fact, the
sirens are already wailing as the yields on 3 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.
CODE RED; Emergency planning now underway
So, what 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.
"What 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)
If Geithner's 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.
Representatives 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.
Other recommendations 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.
"Emergency 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.
By Mike Whitney
fergiewhitney@[EMAIL PROTECTED]
is a well respected freelance writer living in Washington state,
interested in politics and economics from a libertarian perspective.
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