"Facts do not cease to exist because they are ignored."
~ Aldous Huxley
The 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 $330 billion ARS market has dried up
overnight pushing up rates as high as 20% 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.
The price 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.
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It 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.
According to a recent Bloomberg article:
The 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's a simple formula; less money means
less economic activity, less growth, fewer jobs, tighter budgets,
more pain.
Bloomberg continues:
The banks 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.
An article which appeared on the front page of the Financial
Times last week, illustrates how hard-pressed the banks really
are:
The Fed's new Term Auction
Facility "allows the banks to borrow money against all sort
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."
The move 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.) (The story appeared nowhere 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.
In 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
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.
The 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.
Now 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. 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:
How odd? So, when all else fails, tell the truth?
But 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 industry.
Surprised?
The upcoming 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.
