"The current crisis is not only the bust that
follows the housing boom, it's basically the end of a 60-year period of
continuing credit expansion based on the dollar as the reserve currency. Now
the rest of the world is increasingly unwilling to accumulate
dollars." --George Soros, World Economic Forum in Davos,
Global market turmoil continued into a second week as stock
markets in Asia and Europe took another tumble on Monday on growing fears of a
recession in the United States.
China's benchmark index plummeted 7.2 percent to its lowest
point in six months, while Japan's Nikkei index slipped another 4.3 percent.
Equities markets across Asia recorded similar results and, by midmorning in
Europe, all three major indexes -- the UK FTSE �Footsie,� France's CAC 40, and
the German DAX -- were all recording heavy losses. It's now clear that Fed
Chairman Bernanke's 'surprise' announcement of a 75 basis points cut to the Fed
Funds rate last week has neither stabilized the markets nor restored confidence
among jittery investors.
In Monday's Financial Times, Harvard economics professor,
Lawrence Summers, made an impassioned plea for further government
action in addition to the Fed's rate cuts and Bush's $150 billion
�stimulus plan.� Summers believes that steps must be taken immediately to
mitigate the damage from the sharp downturn in housing and persistent troubles
in the credit markets. He suggests a �global coordination of policy,� which is
another way of admitting that the Fed has lost control of the system and cannot
solve the problem by itself.
Summers is right, although it's easy to wonder why he
remained silent while the markets were soaring and the investment banks were
reaping trillions of dollars in profits on a �structured investment� swindle
which has left the global financial system teetering on the brink of
catastrophe. Now that the US economy is sliding towards recession, Summers
is calling for �transparency.� How convenient.
�Financial institutions are holding all sorts of credit
instruments that are impaired but are difficult to value, creating uncertainty
and freezing new lending. Without more visibility, the economy and financial
system risk freezing up as Japan�s did in the 1990s,� said Summers.
Right again. The banks are �capital impaired� because they
are holding nearly $600 billion in mortgage-backed assets which are declining
in value every month. This is forcing many banks to conceal their real
condition from investors while they scour the planet for the extra capital they
need to continue operations. As long as the banks are in distress, consumer and
business lending will dwindle and the economy will continue to shrink. The main
gear in the credit-generating mechanism is now broken. The rate cuts can
provide liquidity, but they cannot bring insolvent banks back from the
dead. Summers is expecting too much.
The United States has led the world into the greatest credit
bust in history, and yet, few people even know what has transpired. The
US's massive current account deficit (nearly $800 billion) has been recycling
into US Treasuries and securities from foreign investors. Up to this point,
American markets were an attractive place to put one's savings. The dollar
was strong, and the stock market had a proven record of profitability and
transparency. But since President Bill Clinton signed the repeal Glass-Steagall
in 1999, the markets have been reconfigured according to an entirely new model,
Glass-Steagall was the last of the Depression-era bulwarks
against the merging of commercial and investment banks. As a result, banking
has changed from a culture of �protection� (of deposits) to �risk taking,�
which is the securities business. Through �financial innovation� the investment
banks created myriad structured debt instruments which they sold through their
Enron-like �off balance� sheets operations (SIVs and Conduits). Now, trillions
of dollars of these subprime and mortgage-backed bonds -- many of which were
rated triple A -- are held by foreign banks, retirement funds, insurance
companies, and hedge funds. They are steadily losing value with every rating's
here for a graph which illustrates how the scam works.)
Summers, of course, understands the enormity of the swindle
that has taken place beneath the noses of US regulators, but chooses not to
hold any of the main actors accountable. Instead, he draws our attention
to a little known part of the market which will probably lead the way to a
stock market crash and a system-wide meltdown.
Here's Summers: �It is critical that sufficient capital is
infused into the bond insurance industry as soon as possible. Their failure or
loss of a AAA rating is a potential source of systemic risk. Probably it will
be necessary to turn in part to those companies that have a stake in guarantees
remaining credible because they have large holdings of guaranteed paper. It
appears unlikely that repair will take place without some encouragement and
involvement by financial authorities. Though there are many differences and the
current problem is more complex, the Long-Term Capital Management work-out is
an example of successful public sector involvement.�
Some of the largest bond insurers are currently unable to
cover the losses that are piling up from the meltdown in mortgage-backed
securities (MBS) and collateralized debt obligations (CDO). Their business
model is hopelessly broken and they will require an immediate $143 billion
bailout to maintain operations. The largest of the bond insurers is MBIA.
"MBIA's total exposure to bonds backed by mortgages and
CDOs was disclosed to be $30.6 billion, including $8.14 billion of holdings of
CDO-squareds [eds note: pure garbage]. MBIA was being priced as a weak
CCC-rated credit when it issued its bonds last week; it is now being priced for
a bankruptcy. MBIA's stock, which traded just under $68 per share last October,
dropped another $3.50 this morning to under $10.00 per share.� [Stock analyst
Michael Lewitt, quoted in Bloomberg]
Barclay's estimates that the investment banks alone are
holding as much as $615 billion of structured securities guaranteed by bond
insurers. If the insurers default, hundreds of billions will be lost via
So, in practical terms, what does it mean if the bond
insurers go under?
It means that the system will freeze and the stock market
will crash. Here's how TV stock guru Jim Cramer summed it up last week in an
interview with MSNBC's Chris Matthews: �But, Chris, there is something I would
urge all the candidates to think about and our treasury secretary, which is
that there are a group of insurance companies which insure all these bad
mortgages and, Chris, I think they are all about to go belly-up, and that will
cause the Dow Jones to decline 2,000 points. They've got to be shut down and
the insurance given to a New Resolution Trust. This is going to happen in maybe
two or three weeks, Chris, it going to on the front of every newspaper and no
one in Washington is even willing to admit it."
Chris Matthews: �So who are you including in these mortgage
companies that are going to go belly-up; give me a description?"
Jim Cramer: "These are MBIA and Ambac remember the
companies that Merrill Lynch and Citigroup wrote down a lot of stuff the other
day? All these companies are relying on insurance to save them. The insurers
don't have the money. There's also personal mortgage insurance; that's PMI, is
one company; MGIC is another. Chris, I am telling you that these companies do
not have the capital to 'make good.' And when they do fall, and I believe it is
when -- if the government does not have a plan in action, you will not be able
to open the stock market when they collapse. No one is even talking about the
fact that these major insurers, who insure $450 billion of mortgages are all
about to go under.�
the whole video.)
Cramer is correct in assuming that the market
won't open. And yet, so far, nothing has been done to avert the
disaster which lies just ahead. Maybe nothing can be done?
So, how did things get so bad, so fast? How could the
world's most resilient and profitable markets be transformed into a carnival
sideshow peddling poisonous �mortgage-backed� snake-oil to every gullible
Author and stock market soothsayer Pam Martens puts it like
this: �How could a layered concoction of questionable debt pools, many of
dubious origin, achieve the equivalent AAA rating as U.S. Treasury securities,
backed by the full faith and credit of the U.S. government, and time-tested over
a century of panics, crashes and the Great Depression?
"How did a 200-year old "efficient" market
model that priced its securities based on regular price discovery through
transparent trading morph into an opaque manufacturing and warehousing complex
of products that didn't trade or rarely traded, necessitating pricing based on
statistical models?� [The
Free Market Myth Dissolves into Chaos, Pam Martens, CounterPunch]
The answer to all these questions is �deregulation.� The
financial system has been handed over to scam-artists and fraudsters who've
created a multi-trillion dollar inverted pyramid of shaky, hyper-inflated,
subprime slop that they've sold around the world with the tacit support of the
ratings agencies and the US political establishment. (wink, wink) Now that
system is about to collapse and there's nothing that the Federal Reserve can do
to stop the Great Credit Unwind of '08.
As economist Ludwig von Mises said, "There is no
means of avoiding the final collapse of a boom brought on by credit expansion.
The question is only whether the crisis should come sooner as a result of a
voluntary abandonment of further credit expansion, or later as a final and
total catastrophe of the currency system involved."
Whitney lives in Washington state. He can be reached at firstname.lastname@example.org.