By now, youve
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. Its
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.
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.
Rock doesnt 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.
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 Rocks business soared. Now they carry
a mortgage book totaling US$200 billion dollars.
So why cant they pay out a paltry $4 or $5 billion to their
customers without a government bailout?
because they dont have the reserves and because the banks
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 dont want them. So Northern Rock
is stuck with a $200 billion albatross thats dragging them
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... Wall
Street created an illusion that risk was somehow disseminated
among the masses."
John R. Ing
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 theyre 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 from
interesting to know if Paulson still believes that "This
is far and away the strongest global economy Ive 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?
weve 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 its 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.
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). Its madness; but no one seemed to realize
how crazy it was until Bear Stearns blew up and they couldnt
find bidders for their remaining CDOs. Its been downhill
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":
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 alongside 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."
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.
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. Its a swindle of epic proportions and it never
would have taken place in a sufficiently regulated market.
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 Bushs "free market" nostrums
or Paulsons soothing bromides (he thinks the problem is
"contained") or Bernankes feeble rate cuts. This
requires real leadership.
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.
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.
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 Feds
emergency bailout program, the "Discount Window":
borrowing under the Feds primary credit program for banks
surged to more than $7.1 billion outstanding as of Wednesday,
up from $1 billion a week before."
see the same pattern developing; the banks borrowing money from
the Fed because they cannot meet their minimum reserve requirements.
Fed in its weekly release said average daily borrowing through
Wednesday rose to $2.93 billion."
the "Discount Window" has only been used by banks in
distress, but the Fed is trying to convince people that its
really not a sign of distress at all. Its "a sign of
strength". Baloney. Banks dont borrow $3 billion unless
they need it. They dont have the reserves. Period.
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.
Jon Markman offered these words of advice to the financial giants:
(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."
Well 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 Feds fund rate that could send the
stock market roaring back into positive territory. [Editor's note:
On September 18, 2007, the U.S. Federal Reserve cut interest rate
to 4.75 per cent from 5.25 per cent.]
we see the same pattern developing; the banks borrowing
money from the Fed because they cannot meet their minimum
reserve requirements. Traditionally,
the "Discount Window" has only been used by
banks in distress, but the Fed is trying to convince
people that its really not a sign of distress
at all. Its "a sign of strength". Baloney.
Banks dont borrow $3 billion unless they need
it. They dont have the reserves. Period.
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."
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 Greenspans misguided monetary
policies. (For which he now blames Bush!) The Feds job is
to ensure price stability and the smooth operation of the markets,
not to reflate equity bubbles and reward over-exposed market participants.
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
is no liquidity problem, but a serious crisis of confidence,"
"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; were
this: In 2000, when Bush took office, gold was $273 per ounce,
oil was $22 per barrel and the euro was worth $0.87 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,
were likely to see oil at $125 per barrel by next spring.
is soaring. The government statistics are thoroughly bogus. Gold,
oil and the euro dont 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)
18.4 per cent a year, and yet Bernanke is still considering cutting
interest rates and further fueling inflation.
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. .
rate cut may be boon to the "cheap credit" addicts on
Wall Street, but its the death-knell for the average worker
who is already struggling just to make ends meet.
No rate cuts. Let the banks and hedge funds sink or swim like
everyone else. The message to Bernanke is simple: "Its
time to take away the punch bowl".
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":
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
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;
this: In 2000, when Bush took office, gold was $273
per ounce, oil was $22 per barrel and the euro was worth
$0.87 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, were 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 dont lie.
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.
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 greenbacks
increasingly shaky position as the worlds "reserve
currency". That could destabilize the global economy by rapidly
unwinding the U.S. massive current account deficit.
Herald Tribune summed up the dollars problems in a recent
article, "Dollar's Retreat Raises Fear of Collapse."
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.
all pointing to a greatly increased risk of a fast unwinding of
the U.S. current account deficit and a serious decline of the
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 cant take a chance that his
effort to rescue the markets will cause a sudden sell-off of the
The Fed chiefs
hands are tied. Bernanke simply doesnt 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 policy changes.
wont 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.
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,
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.
know his decision soon enough.
Mike Whitney is a well respected freelance writer living in Washington
state, interested in politics and economics from a libertarian
perspective. He can be reached at email@example.com.
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