[Dialogue] http://www.informationclearinghouse.info/article19531.htm

[George Holcombe]

NEWS YOU WON'T FIND ON CNN

   Send Page To a Friend

Roubini's Nightmare Scenario;
A Vicious Circle Ending In A Systemic Financial Meltdown
By Mike Whitney
13/03/08 "ICH" -- - "It's another round of the credit crisis. Some  
markets are getting worse than January this time. There is fear that  
something dramatic will happen and that fear is feeding itself,"  
Jesper Fischer-Nielsen, interest rate strategist at Danske Bank,  
Copenhagen; Reuters
Yesterday's action by the Federal Reserve proves that the banking  
system is insolvent and the US economy is at the brink of collapse. It  
also shows that the Fed is willing to intervene directly in the stock  
market if it keeps equities propped up. This is clearly a violation of  
its mandate and runs contrary to the basic tenets of a free market.  
Investors who shorted the market yesterday, got clobbered by the not  
so invisible hand of the Fed chief.
In his prepared statement, Bernanke announced that the Fed would add  
$200 billion to the financial system to shore up banks that have been  
battered by mortgage-related losses. The news was greeted with  
jubilation on Wall Street where traders sent stocks skyrocketing by  
416 points, their biggest one-day gain in five years.
“It's like they're putting jumper cables onto a battery to kick-start  
the credit market,'' said Nick Raich, a manager at National City  
Private Client Group in Cleveland. ``They're doing their best to try  
to restore confidence.''
“Confidence”? Is that what it's called when the system is bailed out  
by Sugar-daddy Bernanke?
To understand the real meaning behind the Fed's action; it's worth  
considering some of the stories which popped up in the business news  
just days earlier. For example, last Friday, the International Herald  
Tribune reported:
“Tight money markets, tumbling stocks and the dollar are expected to  
heighten worries for investors this week as pressure mounts on central  
banks facing what looks like the “third wave” of a global credit  
crisis....Money markets tightened to levels not seen since December,  
when year-end funding problems pushed lending costs higher across the  
board.”
The Herald Tribune said that troubles in the credit markets had pushed  
the stock market down more than 3 percent in a week and that the same  
conditions which preceded the last two crises (in August and December)  
were back stronger than ever. In other words, liquidity was vanishing  
from the system and the market was headed for a crash.
A report in Reuters reiterated the same ominous prediction of a “third  
wave” saying:

“The two-year U.S. Treasury yields hit a 4-year low below 1.5 percent  
as investors flocked to safe-haven government bonds....The cost of  
corporate bond insurance hit record highs on Friday and parts of the  
debt market which had previously escaped the turmoil are also getting  
hit.”

Risk premiums were soaring and investors were fleeing stocks and bonds  
for the safety of government Treasuries; another sure sign that  
liquidity was disappearing.

Reuters: "The level of financial stress is ... likely to continue to  
fuel speculation of more immediate central bank action either in the  
form of increased liquidity injections or an early rate cut," Goldman  
Sachs said in a note to clients.”

Indeed. When there's a funding-freeze by lenders, investors hit the  
exits as fast as their feet will carry them. That's why the lights  
started blinking red at the Federal Reserve and Bernanke concocted a  
plan to add $200 billion to the listing banking system.

New York Times columnist Paul Krugman also referred to a “third wave”  
in his article “The Face-Slap Theory”. According to Krugman, “The Fed  
has been cutting the interest rate it controls - the so-called Fed  
funds rate – (but) the rates that matter most directly to the economy,  
including rates on mortgages and corporate bonds, have been rising.  
And that's sure to worsen the economic downturn.”...(Now) “the banks  
and other market players who took on too much risk are all trying to  
get out of unsafe investments at the same time, causing significant  
collateral damage to market functioning.” What the Times' columnist is  
describing is a run on the financial system and the onset of “a full- 
fledged financial panic.”

The point is, Bernanke's latest scheme is not a remedy for the  
trillion dollar unwinding of bad bets. It is merely a quick-fix to  
avoid a bloody stock market crash brought on by prevailing conditions  
in the credit markets.

Bernanke coordinated the action with the other members of the global  
banking cartel---The Bank of Canada, the Bank of England, the European  
Central Bank, the Federal Reserve, and the Swiss National Bank---and  
cobbled together the new Term Securities Lending Facility (TSLF),  
which “will lend up to $200 billion of Treasury securities to primary  
dealers secured for a term of 28 days (rather than overnight, as in  
the existing program) by a pledge of other securities, including  
federal agency debt, federal agency residential-mortgage-backed  
securities (MBS), and non-agency AAA/Aaa-rated private-label  
residential MBS. The TSLF is intended to promote liquidity in the  
financing markets for Treasury and other collateral and thus to foster  
the functioning of financial markets more generally.” (Fed statement)

The plan, of course, is wildly inflationary and will put additional  
downward pressure on the anemic dollar. No matter. All of the Fed's  
tools are implicitly inflationary anyway, but they'll all be put to  
use before the current crisis is over.

The Fed's statement continues: “The Federal Open Market Committee has  
authorized increases in its existing temporary reciprocal currency  
arrangements (swap lines) with the European Central Bank (ECB) and the  
Swiss National Bank (SNB). These arrangements will now provide dollars  
in amounts of up to $30 billion and $6 billion to the ECB and the SNB,  
respectively, representing increases of $10 billion and $2 billion.  
The FOMC extended the term of these swap lines through September 30,  
2008.”

So, why is the Fed issuing loans to foreign banks? Isn't that a tacit  
admission of its guilt in the trillion dollar subprime swindle? Or is  
it simply a way of warding off litigation from angry foreign investors  
who know they were cheated with worthless toxic bonds? In any event,  
the Fed's largess proves that the G-10 operates as de facto cartel  
determining monetary policy for much of the world. (The G-10  
represents roughly 85% of global GDP)

As for Bernanke's Term Securities Lending Facility (TSLF) it is  
intentionally designed to circumvent the Fed's mandate to only take  
top-grade collateral in exchange for loans. No one believes that these  
triple A mortgage-backed securities are worth more than $.70 on the  
dollar. In fact, according to a report in Bloomberg News yesterday:  
“AAA debt fell as low as 61 cents on the dollar after record home  
foreclosures and a decline to AA may push the value of the debt to 26  
cents, according to Credit Suisse Group.
``The fact that they've kept those ratings where they are is  
laughable,'' said Kyle Bass, chief executive officer of Hayman Capital  
Partners, a Dallas-based hedge fund that made $500 million last year  
betting lower-rated subprime-mortgage bonds would decline in value.  
``Downgrades of AAA and AA bonds are imminent, and they're going to be  
significant.'' Bass estimates most of AAA subprime bonds in the ABX  
indexes will be cut by an average of six or seven levels within six  
weeks.” (Bloomberg News) The Fed is accepting these garbage bonds at  
nearly full-value. Another gift from Santa Bernanke.

Additionally, the Fed is offering 28 day repos which --if this auction  
works like the Fed's other facility, the TAF---the loans can be rolled  
over free of charge for another 28 days. Yippee. The Fed found a way  
to recapitalize the banks with permanent rotating loans and the public  
is none the wiser. The capital-starved banksters at Citi and Merrill  
must feel like they just won the lottery. Unfortunately, Bernanke's  
move effectively nationalizes the banks and makes them entirely  
dependent on the Fed's fickle generosity.

The New York Times Floyd Norris sums up Bernanke's efforts like this:

“The Fed’s moves today and last Friday are a direct effort to counter  
a loss of liquidity in mortgage-backed securities, including those  
backed by Fannie Mae and Freddie Mac. Given the implied government  
guarantee of Freddie and Fannie, rising yields in their paper served  
as a warning sign that the crunch was worsening and investor  
confidence was waning. On Oct. 30, the day before the Fed cut the Fed  
funds rate from 4.75 percent to 4.5 percent, the yield on Fannie Mae  
securities was 5.75 percent. Today the Fed Funds rate is 3 percent,  
and the Fannie Mae rate is 5.71 percent, virtually the same as in  
October.....A sign of the Fed’s success, or lack of same, will be  
visible in that rate. It needs to come down sharply, in line with  
Treasury bond rates. Today, the rate was up for most of the day, but  
it did fall back at the end of the day. Watch that rate for the rest  
of the week to see indications of whether the Fed’s move is really  
working to restore confidence.”

Norris is right; it all depends on whether rates go down and whether  
that will rev-up the moribund housing market again. Of course, that is  
predicated on the false assumption that consumers are too stupid to  
know that housing is in its biggest decline since the Great  
Depression. This is just another slight miscalculation by the  
blinkered Fed. Housing will not be resuscitated anytime in the near  
future, no matter what the conditions; and you can bet on that. The  
last time Bernanke cut interest rates by 75 basis points mortgage  
rates on the 30-year fixed actually went up a full percentage point.  
This had a negative affect on refinancing as well as new home  
purchases. The cuts were a total bust in terms of home sales.

Still, equities traders love Bernanke's antics and, for the next 24  
hours or so, he'll be praised for acting decisively. But as more  
people reflect on this latest manuver, they'll see it for what it  
really is; a sign of panic. Even more worrisome is the fact that  
Bernanke is quickly using every arrow in his quiver. Despite the  
mistaken belief that the Fed can print money whenever it chooses;  
there are balance sheets constraints; the Fed's largess is finite.  
According to MarketWatch:

"Counting the currency swaps with the foreign central banks, the Fed  
has now committed more than half of its combined securities and loan  
portfolio of $832 billion, Lou Crandall, chief economist for Wrightson  
ICAP noted. 'The Fed won't have run completely out of ammunition after  
these operations, but it is reaching deeper into its balance sheet  
than before."


Steve Waldman at interfluidity draws the same conclusion in his latest  
post:

“After the FAF expansion, repo program, and TSLF, the Fed will have  
between $300B and $400B in remaining sterilization capacity, unless it  
issues bonds directly.” (Calculated Risk)
So, Bernanke is running short of ammo and the housing bust has just  
begun. That's bad. As the wave of foreclosures, credit card defaults  
and commercial real estate bankruptcies continue to mount; Bernanke's  
bag o' tricks will be near empty having frittered most of his capital  
away on his Beluga-munching buddies at the investment banks.
But that's only half the story. Bernanke and Co. are already working  
on a new list of hyper-inflationary remedies once the credit troubles  
pop up again. According to the Wall Street Journal, the Fed has other  
economy-busting scams up its sleeve:
“With worsening strains in credit market threatening to deepen and  
prolong an incipient recession, analysts are speculating that the  
Federal Reserve may be forced to consider more innovative responses -–  
perhaps buying mortgage-backed securities directly.

“As credit stresses intensify, the possibility of unconventional  
policy options by the Fed has gained considerable interest, said  
Michael Feroli of J.P. Morgan Chase. He said two options are garnering  
particular attention on Wall Street: Direct Fed lending to financial  
institutions other than banks and direct Fed purchases of debt of  
Fannie Mae and Freddie Mac or mortgage-backed securities guaranteed by  
the two shareholder-owned, government-sponsored mortgage companies.  
( “Rate Cuts may not be Enough”, David Wessel, Wall Street Journal)

Wonderful. So now the Fed is planning to expand its mandate and bail  
out investment banks, hedge funds, brokerage houses and probably every  
other brandy-swilling Harvard grad who got caught-short in the  
subprime mousetrap. Ain't the “free market” great?

But none of Bernanke's bailout schemes will succeed. In fact, all he's  
doing is destroying the currency by trying to reflate the equity  
bubble. And how much damage is he inflicting on the dollar?  								 
According to Bloomberg, “the risk of losses on US Treasury notes  
exceeded German bunds for the first time ever amid investor concern  
the subprime mortgage crisis is sapping government reserves....Support  
for troubled financial institutions in the U.S. will be perceived as a  
weakening of U.S. sovereign credit.''
America is going broke and the rest of the world knows it. Bernanke is  
just speeding the country along the ever-steepening downward trajectory.
Timothy Geithner, President of the New York Fed put it like this:

“The self-reinforcing dynamic within financial markets has intensified  
the downside risks to growth for an economy that is already  
confronting a very substantial adjustment in housing and the  
possibility of a significant rise in household savings. The intensity  
of the crisis is in part a function of the size of the preceding  
financial boom, but also of the speed of the deterioration in  
confidence about the prospects for growth and in some of the basic  
features of our financial markets. The damage to confidence—confidence  
in ratings, in valuation tools, in the capacity of investors to  
evaluate risk—will prolong the process of adjustment in markets. This  
process carries with it risks to the broader economy.”

Without a hint of irony, Geithner talks about the importance of  
building confidence on a day when the Fed has deliberately distorted  
the market by injecting $200 billion in the banking system and sending  
the flagging stock market into a steroid-induced rapture. Astonishing.

The stock market was headed for a crash this week, but Bernanke  
managed to swerve off the road and avoid a head-on collision. But  
nothing has changed. Foreclosures are still soaring, the credit   
								markets are still frozen, and capital is being destroyed at a  
faster pace than any time in history. The economic situation continues  
to deteriorate and even unrelated parts of the markets have now been  
infected with subprime contagion. The massive deleveraging of the  
banks and hedge funds is beginning to intensify and will continue to  
accelerate until a bottom is found. That's a long way off and the road  
ahead is full of potholes.
"In the United States, a new tipping point will translate into a  
collapse of the real economy, final socio-economic stage of the serial  
bursting of the housing and financial bubbles and of the pursuance of  
the US dollar fall. The collapse of US real economy means the virtual  
freeze of the American economic machinery: private and public  
bankruptcies in large numbers, companies and  								public services  
closing down massively.” (Statement from The Global Europe  
Anticipation Bulletin (GEAB)
Is that too gloomy? Then take a look at these eye-popping charts which  
show the extent of the Fed's lending operations via the Temporary  
Auction Facility. The loans have helped to make the insolvent banks  
look healthy, but at great cost to the country's economic welfare. http://benbittrolff.blogspot.com/2008/03/really-scary-fed-charts-march.html
The Fed established the TAF in the first place; to put a floor under  
mortgage-backed securities and other subprime junk so the banks  
wouldn't have to try to sell them into an illiquid market at fire-sale  
prices. But the plan has backfired and now the Fed feels compelled to  
contribute $200 billion to a losing cause. It's a waste of time.

UBS puts the banks total losses from the subprime fiasco at $600  
billion. If that's true, (and we expect it is) then the Fed is out of  
luck because, at some point, Bernanke will have to throw in the towel  
and let some of the bigger banks fail. And when that happens, the  
stock market will start lurching downward in 400 and 500 point  
increments. But what else can be done? Solvency can only be feigned  
for so long. Eventually, losses have to be accounted for and  
businesses have to fail. It's that simple.

So far, the Fed's actions have had only a marginal affect. The system  
is grinding to a standstill. The country's two largest GSEs, Fannie  
Mae and Freddie Mac, which are presently carrying $4.5 trillion of  
loans on their books, are teetering towards bankruptcy. Both are  
gravely under-capitalized and (as a recent article in Barron's shows)  
Fannies equity is mostly smoke and mirrors. No wonder investors   
								are shunning their bonds. Additionally, the cost of corporate  
bond insurance is now higher than anytime in history, which makes  
funding for business expansion or new projects nearly impossible. The  
wheels have come of the cart. The debt markets are upside-down,  
consumer confidence is drooping and, as the Financial Times states, “A  
palpable sense of crisis pervades global trading floors.” It's all  
pretty grim.

The banks are facing a “systemic margin call” which is leaving them  
capital-depleted and unwilling to lend. Thus, the credit markets are  
shutting down and there's a stampede for the exits by the big players.  
Bernanke's chances of reversing the trend are nil. The cash-strapped  
banks are calling in loans from the hedge funds which is causing  
massive deleveraging. That, in turn, is triggering a disorderly unwind  
of trillions of dollars of credit default swaps and other leveraged  
bets. Its a disaster. Economist Nouriel Roubini predicted the whole  
sequence of events six months before the credit markets seized and the  
Great Unwind began”. Here's a sampling of his recent testimony before  
Congress:

Roubini's Testimony before Congress:

“There is now a rising probability of a "catastrophic" financial and  
economic outcome; a vicious circle where a deep recession makes the  
financial losses more severe and where, in turn, large and growing  
financial losses and a financial meltdown make the recession even more  
severe. The Fed is seriously worried about this vicious circle and  
about the risks of a systemic financial meltdown....Capital reduction,  
credit contraction, forced liquidation and fire sales of assets at  
below fundamental prices will ensue leading to a cascading and  
mounting cycle of losses and further credit contraction. In illiquid  
market actual market prices are now even lower than the lower  
fundamental value that they now have given the credit problems in the  
economy. Market prices include a large illiquidity discount on top of  
the discount due to the credit and fundamental problems of the  
underlying assets that are backing the distressed financial assets.  
Capital losses will lead to margin calls and further reduction of risk  
taking by a variety of financial institutions that are now forced to  
mark to market their positions. Such a forced fire sale of assets in  
illiquid markets will lead to further losses that will further  
contract credit and trigger further margin calls and disintermediation  
of credit.

To understand the risks that the financial system is facing today I  
present the "nightmare" or "catastrophic" scenario that the Fed and  
financial officials around the world are now worried about. Such a  
scenario – however extreme – has a rising and significant probability  
of occurring. Thus, it does not describe a very low probability event  
but rather an outcome that is quite possible.”

Roubini has been right from the very beginning, and he is right again  
now. Bernanke can place himself at the water's edge and lift his hands  
in defiance, but the tide will come in and wash him out to sea   
								anyway. The market is correcting and nothing is going to stop  
it.

Click on "comments" below to read or post comments

   Comments (23) Comment (0)

Comment Guidelines
Be succinct, constructive and relevant to the story. We encourage  
engaging, diverse and meaningful commentary. Do not include personal  
information such as names, addresses, phone numbers and emails.  
Comments falling outside our guidelines – those including personal  
attacks and profanity – are not permitted.
See our complete Comment Policy and use this link to notify us if you  
have concerns about a comment. We’ll promptly review and remove any  
inappropriate postings.

Send Page To a Friend

In accordance with Title 17 U.S.C. Section 107, this material is  
distributed without profit to those who have expressed a prior  
interest in receiving the included information for research and  
educational purposes. Information Clearing House has no affiliation  
whatsoever with the originator of this article nor is Information  
ClearingHouse endorsed or sponsored by the originator.)




  Sign up for our Daily Email Newsletter




HOME

COPYRIGHT NOTICE


Video






George Holcombe
Asbury United Methodist Church
1605 38 1/2 St.
Austin, TX 78722
Home: 512/252-2756
Church: 512/477-8122
Mobile 512/294-5952
geowanda at earthlink.net




-------------- next part --------------
An HTML attachment was scrubbed...
URL: http://wedgeblade.net/pipermail/dialogue_wedgeblade.net/attachments/20080314/fa927df1/attachment-0001.html