http://www.blacklistednews.com/view.asp?ID=4286U.S. Banks Brace for Storm Surge as Dollar and Credit System Reel
on Tuesday, September 18, 2007. / By MIKE WHITNEY
By now, you’ve probably seen the photos of the angry customers
queued up outside of Northern Rock Bank waiting to withdraw their money. This is the first big run on a British bank in over
a century. It’s lost an eighth of its deposits in three days. The pictures are headline news in the U.K. but have been
stuck on the back pages of U.S. newspapers. The reason for this is obvious. The same Force 5 economic-hurricane that just
touched ground in Great Britain is headed for America and gaining strength on the way.
On Monday night, desperately trying
to stave off a wider panic, the British government issued an emergency pledge to Northern Rock savers that their money was
safe. The government is trying to find a buyer for Northern Rock.
This is what a good old fashioned bank run looks
like. And, as in 1929, the bank owners and the government are frantically trying to calm down their customers by reassuring
them that their money is safe. But human nature being what it is, people are not so easily pacified when they think their
savings are at risk. The bottom line is this: The people want their money, not excuses.
But Northern Rock doesn’t
have their money and, surprisingly, it is not because the bank was dabbling in risky subprime loans. Rather, NR had unwisely
adopted the model of “borrowing short to go long” in financing their mortgages just like many of the major banks
in the U.S. In other words, they depended on wholesale financing of their mortgages from eager investors in the market, instead
of the traditional method of maintaining sufficient capital to back up the loans on their books.
It seemed like a nifty
idea at the time and most of the big banks in the US were doing the same thing. It was a great way to avoid bothersome reserve
requirements and the loan origination fees were profitable as well. Northern Rock’s business soared. Now they carry
a mortgage book totaling $200 billion dollars.
$200 billion! So why can’t they pay out a paltry $4 or $5 billion
to their customers without a government bailout?
It’s because they don’t have the reserves and because
the bank’s business model is hopelessly flawed and no longer viable. Their assets are illiquid and (presumably) “marked
to model”, which means they have no discernible market value. They might as well have been “marked to fantasy”,it
amounts to the same thing. Investors don’t want them. So Northern Rock is stuck with a $200 billion albatross that’s
dragging them under.
A more powerful tsunami is about to descend on the United States where many of the banks have
been engaged in the same practices and are using the same business model as Northern Rock. Investors are no longer buying
CDOs, MBSs, or anything else related to real estate. No one wants them, whether they’re subprime or not. That means
that US banks will soon undergo the same type of economic gale that is battering the U.K right now. The only difference is
that the U.S. economy is already listing from the downturn in housing and an increasingly jittery stock market.
why Treasury Secretary Henry Paulson rushed off to England yesterday to see if he could figure out a way to keep the contagion
Good luck, Hank.
It would interesting to know if Paulson still believes that “This is
far and away the strongest global economy I’ve seen in my business lifetime”, or if he has adjusted his thinking
as troubles in subprime, commercial paper, private equity, and credit continue to mount?
For weeks we’ve been
saying that the banks are in trouble and do not have the reserves to cover their losses. This notion was originally pooh-poohed
by nearly everyone. But it’s becoming more and more apparent that it is true. We expect to see many bank failures in
the months to come. Prepare yourself. The banking system is mired in fraud and chicanery. Now the schemes and swindles are
unwinding and the bodies will soon be floating to the surface.
“Structured finance” is touted as the “new
architecture of financial markets”. It is designed to distribute capital more efficiently by allowing other market participants
to fill a role which used to be left exclusively to the banks. In practice, however, structured finance is a hoax; and undoubtedly
the most expensive hoax of all time. The transformation of liabilities (dodgy mortgage loans) into assets (securities) through
the magic of securitization is the biggest boondoggle of all time. It is the moral equivalent of mortgage laundering. The
system relies on the variable support of investors to provide the funding for pools of mortgage loans that are chopped-up
into tranches and duct-taped together as CDOs (collateralized debt obligations). It’s madness; but no one seemed to
realize how crazy it was until Bear Stearns blew up and they couldn’t find bidders for their remaining CDOs. It’s
been downhill ever since. The problems with structured finance are not simply the result of shabby lending and low interest
rates. The model itself is defective.
John R. Ing provides a great synopsis of structured finance in his article, “Gold:
The Collapse of the Vanities”:
"The origin of the debt crisis lies with the evolution of America's financial
markets using financial engineering and leverage to finance the credit expansion…. Financial institutions created a
Frankenstein with the change from simply lending money and taking fees to securitizing and selling trillions of loans in every
market from Iowa to Germany. Credit risk was replaced by the "slicing and dicing" of risk, enabling the banks to act as principals,
spreading that risk among various financial institutions….. Securitization allowed a vast array of long term liabilities
once parked away with collateral to be resold along side more traditional forms of short term assets. Wall Street created
an illusion that risk was somehow disseminated among the masses. Private equity too used piles of this debt to launch ever
bigger buyouts. And, awash in liquidity and very sophisticated algorithms, investment bankers found willing hedge funds around
the world seeking higher yielding assets. Risk was piled upon risk. We believe that the subprime crisis is not a one off event
but the beginning of a significant sea change in the modern-day financial markets.”
The investment sharks who
conjured up “structured finance” knew exactly what they were doing. They were in bed with the ratings agencies----off-loading
trillions of dollars of garbage-bonds to pension funds, hedge funds, insurance companies and foreign financial giants. It’s
a swindle of epic proportions and it never would have taken place in a sufficiently regulated market.
When crowds of
angry people are huddled outside the banks to get their money, the system is in real peril. Credibility must be restored quickly.
This is no time for Bush’s “free market” nostrums or Paulson’s soothing bromides (he thinks the problem
is “contained”) or Bernanke’s feeble rate cuts. This requires real leadership.
The first thing to
do is take charge, alert the public to what is going on and get Congress to work on substantive changes to the system. Concrete
steps must be taken to build public confidence in the markets. And there must be a presidential announcement that all bank
deposits will be fully covered by government insurance.
The lights should be blinking red at all the related government
agencies including the Fed, the SEC, and the Treasury Dept. They need to get ahead of the curve and stop thinking they can
minimize a potential catastrophe with their usual public relations mumbo jumbo.
Last week, an article appeared in the Wall
Street Journal, “Banks Flock to Discount Window”. (9-14-07) The article chronicled the sudden up-tick in borrowing
by the struggling banks via the Fed’s emergency bailout program, the “Discount Window”:
borrowing under the Fed’s primary credit program for banks surged to more than $7.1 billion outstanding as of Wednesday,
up from $1 billion a week before.” Again we see the same pattern developing; the banks borrowing money from the Fed
because they cannot meet their minimum reserve requirements. WSJ: “The Fed in its weekly release said average daily
borrowing through Wednesday rose to $2.93 billion.” $3 billion.
Traditionally, the “Discount Window”
has only been used by banks in distress, but the Fed is trying to convince people that it’s really not a sign of distress
at all. It’s “a sign of strength”. Baloney. Banks don’t borrow $3 billio unless they need it. They
don’t have the reserves. Period.
The real condition of the banks will be revealed sometime in the next few weeks
when they report earnings and account for their massive losses in “down-graded” CDOs and MBSs. Market analyst
Jon Markman offered these words of advice to the financial giants:
"Before they (the financial industry) take down
the entire market this fall by shocking Wall Street with unexpected losses, I suggest that they brush aside their attorneys
and media handlers and come clean. They need to tell the world about the reality of their home lending and loan securitization
teams' failures of the past four years -- and the truth about the toxic paper that they've flushed into the world economic
system, or stuffed into Enron-like off-balance sheet entities -- before the markets make them walk the plank.”….”
Since government regulators and Congress have flinched from their responsibility to administer "tough love" with rules forcing
financial institutions to detail the creation, securitization and disposition of every ill-conceived subprime loan, off-balance
sheet "structured investment vehicle," secretive money-market "conduit" and commercial-paper-financing vehicle, the market
will do it with a vengeance."
Good advice. We’ll have to wait and see if anyone is listening. The investment
banks may be waiting until Tuesday hoping that Fed-chief Ken Bernanke announces a cut to the Fed’s fund rate that could
send the stock market roaring back into positive territory.
But interest rate cuts do not address the underlying problems
of insolvency among homeowners, mortgage lenders, hedge funds and (potentially) banks. As market-analyst John R. Ing said,
“A cut in rates will not solve the problem. This crisis was caused by excess liquidity and a deterioration of credit
standards….A cut in the Fed Fund rate is simply heroin for credit junkies.”
The cuts merely add more cheap
credit to a market that that is already over-inflated from the ocean of liquidity produced by former-Fed chief Alan Greenspan.
The housing bubble and the credit bubble are largely the result of Greenspan’s misguided monetary policies. (For which
he now blames Bush!) The Fed’s job is to ensure price stability and the smooth operation of the markets, not to reflate
equity bubbles and reward over-exposed market participants.
It’s better to let cash-strapped borrowers default
than slash interest rates and trigger a global run on the dollar. Financial analyst Richard Bove says that lower interest
rates will do nothing to bring money back into the markets. Instead, lower interest rates will send the dollar into a tailspin
and wreak havoc on the job market.
“There is no liquidity problem, but a serious crisis of confidence," Bove said:
a financial system where there is ample liquidity and a desire for higher rates to compensate for risk, the solution is not
to create more liquidity and lower the rates that are available to compensate for risk. ... (The Fed) cannot reduce fear by
"It is illogical to assume that holders of cash will have a strong desire to lend money
at low rates in a currency that is declining in value when they can take these same funds and lend them at high rates in a
currency that is gaining in value. By lowering interest rates the Federal Reserve will not stimulate economic growth or create
jobs. It will crash the currency, stimulate inflation, and weaken the economy and the job markets".
Bove is right.
The people and businesses that cannot repay their debts should be allowed to fail. Further weakening the dollar only adds
to our collective risk by feeding inflation and increasing the likelihood of capital flight from American markets. If that
happens; we’re toast.
Consider this: In 2000, when Bush took office, gold was $273 per ounce, oil was $22 per
barrel and the euro was worth $.87 per dollar. Currently, gold is over $700 per ounce, oil is over $80 per barrel, and the
euro is nearly $1.40 per dollar. If Bernanke cuts rates, we’re likely to see oil at $125 per barrel by next spring.
is soaring. The government statistics are thoroughly bogus. Gold, oil and the euro don’t lie. According to economist
Martin Feldstein, “The falling dollar and rising food prices caused market-based consumer prices to rise by 4.6 per
cent in the most recent quarter.” (WSJ)
That’s 18.4 per cent a year, and yet Bernanke is still considering
cutting interest rates and further fueling inflation.
What about the American worker whose wages have stagnated for
the last six years? Inflation is the same as a pay-cut for him. And how about the pensioner on a fixed income? Same thing.
Inflation is just a hidden tax progressively eroding his standard of living. Bernanke’s rate cut may be boon to the
“cheap credit” addicts on Wall Street, but it’s the death-knell for the average worker who is already struggling
just to make ends meet.
No bailouts. No rate cuts. Let the banks and hedge funds sink or swim like everyone else. The
message to Bernanke is simple: “It’s time to take away the punch bowl”. The inflation in the stock market
is just as evident as it is in the price of gold, oil or real estate. Economist and author Henry Liu demonstrates this in
his article “Liquidity Boom and the Looming Crisis”:
"The conventional value paradigm is unable to explain
why the market capitalization of all US stocks grew from $5.3 trillion at the end of 1994 to $17.7 trillion at the end of
1999 to $35 trillion at the end of 2006, generating a geometric increase in price earnings ratios and the like. Liquidity
analysis provides a ready answer".(Asia Times)
Market capitalization zoomed from $5.3 trillion to $35 trillion in 12
years? Why?Was it due to growth in market-share, business expansion or productivity?
No. It was because there were more
dollars chasing the same number of securities; hence, inflation.
If that is the case, then we can expect the stock
market to fall sharply before it reaches a sustainable level. As Liu says, “It is not possible to preserve the abnormal
market prices of assets driven up by a liquidity boom if normal liquidity is to be restored.” Eventually, stock prices
will return to a normal range.
Bernanke should not even be contemplating a rate cut. The market needs more discipline
not less. And workers need a stable dollar. Besides, another rate cut would further jeopardize the greenback’s increasingly
shaky position as the world’s “reserve currency”. That could destabilize the global economy by rapidly unwinding
the U.S. massive current account deficit.
The International Herald Tribune summed up the dollar’s problems in
a recent article, "Dollar's Retreat Raises Fear of Collapse."
"Finance ministers and central bankers have long fretted
that at some point, the rest of the world would lose its willingness to finance the United States' proclivity to consume far
more than it produces - and that a potentially disastrous free-fall in the dollar's value would result.
turmoil in mortgage markets has, in a single stroke, shaken faith in the resilience of American finance to a greater degree
than even the bursting of the technology bubble in 2000 or the terror attacks of Sept. 11, 2001, analysts said. It has also
raised prospect of a recession in the wider economy.
"This is all pointing to a greatly increased risk of a fast unwinding
of the U.S. current account deficit and a serious decline of the dollar".
Other experts and currency traders have expressed
similar sentiments. The dollar is at historic lows in relation to the basket of currencies against which it is weighted. Bernanke
can’t take a chance that his effort to rescue the markets will cause a sudden sell-off of the dollar.
chief’s hands are tied. Bernanke simply doesn’t have the tools to fix the problems before him. Insolvency cannot
be fixed with liquidity injections nor can the deeply-rooted “systemic” problems in “structured finance”
be corrected by slashing interest rates. These require fiscal solutions, congressional involvement, and fundamental economic
Rate cuts won’t help to rekindle the spending spree in the housing market either. That charade
is over. The banks have already tightened lending standards and inventory is larger than anytime since they began keeping
records. The slowdown in housing is irreversible as is the steady decline in real estate prices. Trillions in market capitalization
will be wiped out. Home equity is already shrinking as is consumer spending connected to home-equity withdrawals.
bubble has popped regardless of what Bernanke does. The same is true in the clogged Commercial Paper market where hundreds
of billions of dollars in short-term debt is due to expire in the next few weeks. The banks and corporate borrowers are expected
to struggle to refinance their debts but, of course, much of the debt will not roll over. There will be substantial losses
and, very likely, more defaults.
Bernanke can either be a statesman---and tell the country the truth about our dysfunctional
financial system which is breaking down from years of corruption, deregulation and manipulation---or he can take the cowards-route
and buy some time by flooding the system with liquidity, stimulating more destructive consumerism, and condemning the nation
to an avoidable cycle of double-digit inflation.
We’ll know his decision soon enough.
Mike Whitney lives
in Washington state. He can be reached at: email@example.com