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U.S. Banks Brace for Storm Surge as Dollar and Credit System Reel 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. 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. 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. “Discount 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.” 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. "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. 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. "In 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 stimulating inflation… "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. Inflation 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. . 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 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? 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. 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.
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