- "Facts do not cease to exist because they are ignored."
~ Aldous Huxley
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- 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.
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- 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.
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- According to a recent Bloomberg article:
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- "A year ago $20 million would have gotten Luminent
Mortgage Capital Inc. access to $640 million in loans to buy top-rated
mortgage-backed securities. Now that much cash gets the firm no more than
$80 million. ...(Only) 6 lenders are offering 5 times leverage, while a
year ago, 20 banks extended 33 times."
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- 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.
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- Bloomberg continues:
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- "Wall Street firms, reeling from $146 billion in
losses on their debt holdings, are fueling a credit crisis by clamping
down on lending to investors and hedge funds that use borrowed money to
buy securities. By pulling back, (the banks) are contributing to reduced
demand and lower prices throughout the fixed-income world."
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- 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.
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- An article which appeared on the front page of the Financial
Times last week, illustrates how hard-pressed the banks really are:
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- "US banks have been quietly borrowing massive amounts
of money from the Federal Reserve...$50 billion in one month."
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- 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."
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- 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.)
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- 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.
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- 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.
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- 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.
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- 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:
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- "There is plenty of blame to go around for the current
situation. The Federal Reserve bears much of the responsibility, because
of its failure to provide the appropriate supervisory oversight for the
major money center banks. The Fed's banking examiners have complete access
to all of the financial transactions of the banks that they supervise,
and should have the technical expertise to evaluate the risks that those
banks are taking. Because these banks provide credit to the nonbank financial
institutions, the Fed can also indirectly examine what those other institutions
are doing.
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- The Fed's bank examinations are supposed to assess the
adequacy of each bank's capital and the quality of its assets. The Fed
declared that the banks had adequate capital because it gave far too little
weight to their massive off balance-sheet positions the structured
investment vehicles (SIVs), conduits and credit line obligations
that the banks have now been forced to bring onto their balance sheets.
Examiners also overstated the quality of the banks' assets, failing to
allow for the potential bursting of the house price bubble. The implication
of this for Fed supervision policy is clear. The way out of the current
crisis is not."
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- How odd? So, when all else fails, tell the truth?
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- 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.
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- Surprised?
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- 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.
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- Mike Whitney [<mailto:fergiewhitney@msn.com>send
him mail] lives in Washington state.
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