January 10, 2008, US Federal Reserve chairman Ben Bernanke gave
the keynote address on the state of the economy and financial
markets at a luncheon in Washington, DC. The tone of the speech
was decidedly somber and could have easily been accompanied by
a funereal dirge and eight black-suited pall bearers.
Bernanke avoided the opaque, hieroglyphic-filled language of his
predecessor, Alan Greenspan, and gave a clear presentation of
the facts. Unfortunately, the facts are bleak. The economy is
in very bad shape.
market conditions... have produced a volatile situation that has
made forecasting the course of the economy even more difficult
than usual. (We have seen) continued increases in the prices of
energy (as well as) a sharp and protracted correction in the U.S.
housing market. According to the most recent available data, housing
starts and new home sales have both fallen by about 50 per cent
from their respective peaks."
made no effort to conceal the gloomy facts:
about 21 per cent of subprime ARMs are 90 days or more delinquent,
and foreclosure rates are rising sharply ...Fraud and abusive
practices contributed to the high rates of delinquency that we
are now seeing in the subprime ARM market, the more fundamental
reason for the sharp deterioration in credit quality was the flawed
premise on which much subprime ARM lending was based: that house
prices would continue to rise rapidly. (This) will have adverse
effects for communities and the broader economy as well as for
the borrowers themselves."
was equally blunt about the credit crunch that resulted from the
excesses in subprime lending:
the many unfortunate consequences of these events, which may be
with us for some time, is on the availability of credit for nonprime
borrowers... The far-reaching financial impact of the subprime
shock is that it has contributed to a considerable increase in
investor uncertainty about the appropriate valuations of a broader
range of financial assets, not just subprime mortgages. (As a
result) the problems in the subprime mortgage market may lead
overall economic growth to slow."
went on to give a very detailed account of how the banks "underwrote
many of the loans and created many of the structured credit products
(MBS, CDOs, ABCP) that were sold into the market. Banks also supported
the various investment vehicles in many ways, for example, by
serving as advisers and by providing standby liquidity facilities
and various credit enhancements."
As the problems
in subprime have grown, the banks have been forced to
take on more and more of their struggling "off balance" sheet
operations which dramatically increase their debt-load and further
impair their capital base. This explains why the banks have
been reporting huge losses from their deteriorating collateral while their
market value has dropped sharply. Now banks have become more restrictive
in their lending and credit has become more expensive and less
banks are unable to issue loans; the economy suffers.
Ben Bernanke knows, "permanent-rotating loans"
is just a clever euphemism for nationalizing the banks and
monetizing their debts at the taxpayers' expense.
added ominously: "The market strains have been serious, and they
continue to pose risks to the broader economy."
that. Since the troubles began in late summer, the Fed has slashed
rates by a full percentage point to 4.25 per cent and opened a
Discount Window to provide billions of dollars directly to the
banks. The Fed has also opened a Term Auction Facility (TAF) which
has distributed US$40 billion in 30-day repos to over 100 under-capitalized
The Fed is planning to loan another $60 billion in the next
month. These repos are issued secretly (so depositors and shareholders
don't know how bad things really are) and the Fed is accepting
a "wide range of collateral", which means that they are taking
"structured investments" (MBSs, CDOs, ASCP), the same garbage
that no one will buy on the open-market.
In other words, the Fed has established
a multi-billion emergency fund which features permanently-rotating
loans for banks that made poor investments and are, for all
purposes, already bankrupt. This is moral hazard at its absolute
Bernanke knows, "permanent-rotating loans" is just a
clever euphemism for nationalizing the banks and monetizing their
debts at the taxpayers' expense. Many of these institutions are
already insolvent. The Fed is just ensuring that there are no
consequences for their leveraged bets and reckless speculation.
Once again, it's socialism for the rich and capitalism for the
these unprecedented measures do not really solve the basic problems
of credit quality or the serious constraints on lending. For that,
the Fed will have to aggressively slash rates hoping to revive
the sagging economy.
grim (but realistic) forecast:
conditions continue to pose a downside risk to the outlook for
growth.... The financial situation remains fragile, and many funding
markets remain impaired. Adverse economic or financial news has
the potential to increase financial strains and lead to further
constraints on the supply of credit to households and business...
Incoming information has suggested that the baseline outlook for
real activity in 2008 has worsened and the downside risks to growth
have become more pronounced.
"Notably, the demand for housing seems to have weakened further,
in part reflecting the ongoing problems in mortgage markets. In
addition, a number of factors, including higher oil prices, lower
equity prices, and softening home values, seem likely to weigh
on consumer spending as we move into 2008.
outlook for real activity in 2008 has worsened and the downside
risks to growth have become more pronounced." That says it all.
We're headed into recession and it's going to be a doozy.
economy is quickly succumbing to recessionary forces. With
a high degree of confidence we can proclaim that the Mortgage
Crisis has now evolved into a Corporate Debt Crisis - and
this crisis will not be resolved anytime soon - by rates,
by helicopters, or by bailouts.'
Economic analyst Doug Noland
assessment is only slightly different from the bleakest predictions
of the doomsday web sites. Unemployment is on the rise which will
continue to be a drag on consumer spending. Inflation is also
likely to be a concern as the Fed slashes rates and food and energy
prices go through the roof.
Even so, the listless economy is so hobbled by the collapse in
real estate and the subsequent meltdown in the financial markets
that the Fed will be forced to ease rates by at least 50 basis
points at the next Board of Governors meeting followed by further
cuts all the way down to 2.5 per cent (according to Goldman Sachs
and Merrill Lynch). If that's the case, we can expect to pay $4
to $5 for gas by the end of 2009.
Bernanke's candor is a welcome relief from Greenspan's circuitous
"Fed-speak", his dark prognosis does little to address the problems
facing the markets. It's hard to tell whether we are entering
a new era of Fed transparency or if Bernanke has simply taken
the attitude that "When all else fails; tell the truth". That's
hardly a sign of personal virtue.
economic news is now cascading-down from all sides. The dollar
is steadily weakening which sent gold to a new-high of $900 on
Friday. Hours earlier, the Commerce Department reported that the
trade deficit had skyrocketed 9 per cent to $63.1 billion in November.
That puts more pressure on the greenback as foreign investors
will continue to flee the US to markets with greater growth-potential.
nation's largest brokerage firm, Merrill Lynch, is expected to
report losses of $15 billion on soured mortgage-backed securities.
The nation's largest bank, Citigroup, is expected to report even
bigger losses of $25 billion on similar investments. The nation's
largest mortgage-lender, Countrywide, will (allegedly) face bankruptcy
if Bank of America's $4 billion bid for the ailing company is
not accepted. And, the nation's largest bond insurer, MBIA Inc.,
may need to raise $10 billion in capital to keep its AAA credit
rating (said William Ackman, president of Pershing Square Capital
picture? The giants of the financial industry are either on the
brink of annihilation or they have joined the long conga-line
of haggard CFOs who are on their way to Beijing with begging bowl
in hand. Battered banks and corporations are increasingly forced
to get capital in the only place it is still available; China
and the oil producing countries. Thus, the life's-blood of capitalism
now surges through a communist artery. How's that for irony?
11, the RBC Cash Index reported that consumer confidence had fallen
to an all-time low. The US consumer is over-extended, underpaid,
and worried about everything from his soaring energy bills, to
diminishing job security, to the mass foreclosures. The report
was released just hours before the Dow Jones Industrial Average
took a 246 point swan-dive in heavy trading. The prevailing mood
on Wall Street is gloomy and the feeling is that the worst is
yet to come. Judging by the extraordinary steps taken by the Fed;
we could be facing a Force 5 fiscal-hurricane.
soothsayer Doug Noland summed it up like this:
Finance Bubble is a bust, Wall Street finance is imploding, and
foreign financial institutions are keen to cut and run from the
business of providing U.S. Credit... Worse yet, the economy is
quickly succumbing to recessionary forces. With a high degree
of confidence we can proclaim that the Mortgage Crisis has now
evolved into a Corporate Debt Crisis - and this crisis will not
be resolved anytime soon - by rates, by helicopters, or by bailouts."
(Doug Noland "Mortgage Crisis to Corporate Debt Crisis", Prudent
your honesty, Ben, but all the exits appear to be bolted-shut.
We'll have to ride this storm out from inside the bunker.
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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