One picture tells the whole story. It's a photo of five
grim looking men in gray suits staring ahead blankly like they were in the dock
with Saddam awaiting sentencing. Every one of them looks downcast and dejected;
shoulders rounded and jaws set. This is what desperation looks like, which is
why the photo was kept off the front pages of the leading newspapers.
The group took no questions and, as far as the media was
concerned, the meeting never happened. But it did happen; and it happened on
Monday at the White House at 2PM. That's when President Bush convened the
Working Group on Financial Markets, also known as the Plunge Protection Team,
to explain their strategy for dealing with deteriorating conditions in the
financial markets. The details of the meeting remain unknown, but judging by
the sudden (and irrational) recovery in the stock market on Tuesday; their plan
must have succeeded.
The Plunge Protection Team is a panel that includes Fed
Chairman Ben Bernankee, Treasury Secretary Henry Paulson, Securities and
Exchange Commission Chairman Christopher Cox, and acting Commodity Futures
Trading Commission head Walter Lukken. According to John Crudele of the New
York Post, the Plunge Protection Team's (PPT) objective is to redirect the
stock market by "buying market averages in the futures market, thus
stabilizing the market as a whole." In the event of a terrorist attack or
a natural disaster, the group's activities could play an extremely positive
role in saving the market from an unnecessary meltdown. However, direct
intervention into supposedly "free markets" is less defensible when
it is merely a matter of saving an overleveraged banking system from its
inevitable Day of Reckoning. And, yet, that appears to be the reason for
the White House confab; to buy a little more time before the final explosion.
The psychology behind the PPT's activities is explained
in greater detail by Robert McHugh Ph.D. who provides a description of how it
works in his essay, The Plunge Protection Team Indicator: "The PPT decides
markets need intervention, a decline needs to be stopped, or the risks
associated with political events that could be perceived by markets as highly
negative and cause a decline, need to be prevented by a rally already in
flight. To get that rally, the PPT's key component -- the Fed -- lends money to
surrogates who will take that fresh electronically printed cash and buy markets
through some large unknown buyer's account. That buying comes out of the blue
at a time when short interest is high. The unexpected rally strikes blood, and
fear overcomes those who were betting the market would drop. These shorts need
to cover, need to buy the very stocks they had agreed to sell (without owning
them) at today's prices in anticipation they could buy them in the future at
much lower prices and pocket the difference. Seeing those stocks rally above
their committed selling price, the shorts are forced to buy -- and buy they do.
Thus, those most pessimistic about the equity market end up buying equities
like mad, fueling the rally that the PPT started. Bingo, a huge turnaround
rally is well underway, and sidelines money from hedge funds, mutual funds and
individuals' rush in to join in the buying madness for several days and weeks
as the rally gathers a life of its own."
The powers of the
PPT are greatly exaggerated; eventually the liquidity they provide has to be
drained from the system. The popular myth that the Fed simply creates as much
money as it chooses and spreads it around like confetti is pure rubbish. The
Fed has very definite balance constraints. The system is not quite as rigged as
many people imagine. According to Bloomberg News, the Fed has already depleted
most of its resources: "The Fed has committed as much as 60 percent
of the $709 billion in Treasury securities on its balance sheet to providing
liquidity and opened the door to more with yesterday's decision to become a
lender of last resort for the biggest Wall Street dealers."
["Bernanke May Run Low on Ammunition for Loans, Rates," Bloomberg]
The troubles in the credit markets and real estate are
bigger than the Fed or the PPT and they know it. The next step is massive
government intervention; mortgage rate freezes, bailouts and fiscal stimulus.
Big government is back; Reaganism has gone full circle. That doesn't mean that
the PPT cannot have an important psychological affect in soothing jittery
markets or stalling a system-wide collapse. It just means, that markets
will eventually correct regardless of what anyone does to stop them. The sharp
downturn in the financial markets is the result of unsustainable credit
expansion that can't be fixed by the parlor tricks of the PPT. The rate at
which financial institutions are deleveraging and destroying capital will
inevitably trigger an economic crisis equal to the Great Depression. What is
needed is strong leadership and a recommitment to transparency, not "more
of the same" low interest crack and financial hanky-panky. It's time to
come clean with the public and admit we have a problem.
"Sucker rallies", like last Tuesday's
400-point surge on Wall Street just helps to conceal the deeply rooted
problems that need to be addressed before investor confidence can
be restored. Blogger Rick Ackerman summed it up succinctly, "These
psychotic, 400-point rallies in the Dow do not augur renewed confidence. They
are being driven almost entirely by short-covering, and even the otherwise clueless
news anchors are starting to dismiss them as meaningless. One of these days,
moments after the last surviving bear's short position has been liquidated,
stocks are going to fall so steeply that even the Plunge Protection Team will
call for back-up. Then, the financial collapse that so many have been expecting
will unfold in just a few days, with enough power to leave the global economy
in ruins for a generation." [Rick's Picks, Rick Ackerman]
Whether Ackerman's dire predictions materialize or not,
there's no denying that the situation is getting worse by the day. In the last
few weeks alone, two major financial institutions, Carlyle Capital and Bear
Stearns have either gone under or been bailed out, wiping out tens of billions
in market capitalization. These flameouts have increased the rate of the
deflation adding to the already prodigious losses from housing foreclosures,
delinquent credit card debt, defaulting car loans, and the deleveraging in
the hedge fund industry. Fortress America has sprung a leak, and capital is
escaping in a torrent.
"One thing is for certain, we're in challenging
times," Bush opined on last Monday after meeting with his top economic
aides. ""But we are on top of the situation."
That's comforting. Bush is all over it.
Last week's 75 basis point rate cut by the Fed
is another sign of desperation. The Fed Funds rate is now 2 percentage
points below the rate of inflation, an obvious attempt by Bernanke to reflate
the equity bubble at the expense of the dollar. Is that why Wall Street was so
jubilant; another savage blow to the currency?
The Fed's statement was as bleak as any they have ever
released, sounding more like passages from the Book of the Dead than minutes of
the Federal Open Market Committee: "Recent information indicates that the
outlook for economic activity has weakened further. Growth in consumer spending
has slowed and labor markets have softened. Financial markets remain under
considerable stress, and the tightening of credit conditions and the deepening
of the housing contraction are likely to weigh on economic growth over the next
"Inflation has been elevated, and some indicators of
inflation expectations have risen. . . . uncertainty about the inflation outlook
has increased. It will be necessary to continue to monitor inflation
action . . . should help to promote moderate growth over time and to mitigate
the risks to economic activity. However, downside risks to growth remain."
Wall Street rallied on the cheery news.
Also last Tuesday, the battered investment banks began
posting first quarter earnings which turned out to be better than
expected. Goldman Sachs Group, Inc., and Lehman Brothers Holdings, Inc., beat estimates
which added to the stock market giddiness. Unfortunately, a careful reading of
the reports shows that things are not quite as they seem. The jubilation
is unwarranted; it's just more smoke and mirrors.
Brothers Holdings, Inc., reported a 57 percent drop in fiscal first-quarter net
income amid weakness in its fixed-income business, though results topped
analysts' expectations." [Wall Street Journal]
The same was true of
financial giant Goldman Sachs: "Goldman Sachs Group, Inc.'s fiscal first-quarter
net income dropped 53 percent on $2 billion in losses on residential mortgages,
credit products and investments . . . The biggest Wall Street investment bank
by market value reported net income of $1.51 billion, or $3.23 a share, for the
quarter ended Feb. 29, compared to $3.2 billion, or $6.67 a share, a year
earlier. . . . Results included $1 billion in losses on residential mortgage
loans and securities, and nearly $1 billion in losses on credit products and
investment losses . . ." [Wall Street Journal]
The bottom line is
that both companies first quarter earnings dropped by more than a half in just
one year alone while, at the same time, they booked heavy losses. That's hardly
a reason for celebration. The major investment banks remain on the critical
list because of the billions of dollars of toxic debt they still carry on their
balance sheets. Consider industry leader Goldman Sachs, for example, which
is sitting on a backlog of bad paper from the subprime/securitization debacle
as well as an unknown amount of LBOs (Leveraged buyouts) and commercial real
estate deals (CREs) that are heading south fast. Market analyst, Mark
Gongloff, sheds a bit of light on the real condition of the big financials in
his article, ""Crunch Proves A Test of Faith For Street Strong":
"All of the brokerage houses are highly leveraged, with a high
ratio of assets to shareholders' equity, a sign they have used debt heavily to
build up positions in hope of greater returns. Morgan Stanley, which will
report Wednesday, had a leverage ratio of 32.6-to-1 at the end of last year,
nearly as high as Bear's 32.8-to-1. Lehman was leveraged 30.7-to-1, and Merrill
Lynch 27.8-to-1. And the would-be rock, Goldman? It was leveraged 26.2-to-1.
" ["Crunch Proves A Test of Faith For Street Strong", WSJ]
Remember, Carlyle Capital was leveraged 32 to 1 ($22 billion
equity) and went ""poof"" in a matter of days when it
couldn't scrape together a measly $400 million for a margin call. How
vulnerable are these other maxed-out players now that the credit bubble has
popped and the whole system is quickly unwinding?
Not very safe, at
all. As Gongloff points out: "Based in part on numbers reported at
the end of Bear's fourth quarter, estimated that Bear Stearns had $35 billion
in liquid assets and borrowing capacity, enough to operate for 20 months. Turns
out it had enough for three days."
That's right, three days and it was over. Why would anyone
think it will be different with these other equally-exposed banks? These
institutions are basically insolvent now. The Federal Reserve is just trying to
prop them up to maintain appearances. But it's a hopeless cause. As
hyper-inflated assets are downgraded; structured investments and
arcane hedges against default will continue to disintegrate and these profligate
institutions will be crushed by a stampede of panicking investors. The
flight to safety has already begun. Cash is king.
Look what has transpired just since last Monday.
"Crude oil, copper and coffee led the
biggest decline ever in commodities on speculation that a U.S.
recession will stall demand for raw materials." [Bloomberg] All asset
classes fall in a deflationary spiral, even commodities which many people
thought would be spared. Not so. In fact, even gold has begun to retreat as
hedge funds and other market participants are forced to relinquish their
In other news, Reuters reports: "The yield on U.S.
3-month Treasury bills fell below 1 percent on Monday to levels not seen in 50
years prompted by intense safety bids for cash spurred by the ongoing global
credit crunch . . . Investors were pulling money out of stocks and even the
booming commodity market even after the Federal Reserve conducted a fresh round
of measures over the weekend to alleviate the credit crisis."
Here's another example of the "flight to
safety" as investors recognize the warning signs of deflation. This
trend is likely to intensify even though the Fed will continue to cut
rates and real earnings on Treasuries will go negative.
In another report from Reuters: ""The Chicago
Board Options Exchange Volatility Index or VIX on Monday surged to its highest
level in nearly two months as a fire sale of Bear Stearns and an emergency
Federal Reserve cut in the discount rate reignited credit fears."
Fear is higher now than it has been in a long time. Option
traders are loading up on index puts in the Standard & Poor's 500 index.
The "Fear Gage, as it is called, is soaring to new heights as credit
problems continue to mount and business begins to slow to a crawl.
And, perhaps most important of all: "The cost of
borrowing in dollars overnight rose by the most in at least seven years after
the Federal Reserve's emergency cut in the discount interest rate stoked
concern that credit losses are deepening. . . . The London interbank offered
rate, or Libor climbed 81 basis points to 3.86 percent, the British Bankers'
Association said today. It was the biggest increase since at least January
2001. The comparable pound rate rose 28 basis points to 5.59 percent, the
largest gain since Dec. 31, 2007." [Bloomberg]
This may sound like technical gibberish geared for market
junkies, but it is critical for understanding the gravity of what is
really going on. The Fed's rate cuts are not normalizing the
lending between banks. In fact, the situation is actually
deteriorating quite quickly. When banks don't lend to each other (because they
are worried about getting their money back), the wheels of capitalism grind to
a halt. The banks are the essential conduit for providing credit to the broader
economy. If there's a slowdown in traffic, economic growth begins to slow
immediately. Presently, the banks are hoarding cash to cover the losses on
their mortgage-backed investments and to shore up their skimpy capital
reserves. As a result, consumer spending is sluggish and GDP is beginning
"We know we're in a sharp (decline), and there's no
doubt that the American people know that the economy has turned down
sharply," said Henry Paulson on NBC television on Sunday, March 16.
"There's turbulence in our capital markets and it's been going on since
August. We're looking for ways to work our way through it."
No kidding. But Paulson is clearly out of his depth.
He's simply not the man to deal with a crisis of this magnitude. His
only concern is bailing out his rich friends in the banking industry. The
interests of workers and consumers are just brushed aside. Has anyone from the
Dept. of the Treasury (or the Fed) suggested a bailout for the 14,000 Bear
Stearns employees who just lost not only their jobs but their entire retirement
funds when the company was purchased by JP Morgan?
Of course, not. Because both Paulson and Bernanke take a
class oriented approach to the problem that narrows their range of vision and
limits their ability to pose viable remedies. They are unable to see the whole
playing field. For example, Bernanke assumes that if he keeps cutting rates, he
can reflate the equity bubble by stimulating consumer spending. But
that is not going happen. First of all, the banks are not passing on
the savings to customers. And, second, the banks are only lending to applicants
with a flawless credit history. In other words, the Fed's cuts may be good for
Bernanke and Paulson's buddies, but they do nothing for either the consumer or
the broader economy. Also, as Michael Hudson notes in his latest article, Save the Economy, Dismantle the Empire, the banks
are taking the money they borrow from the Fed and investing it
elsewhere: "This week the Fed tried to reverse the plunge in asset prices
by flooding the banking system with $200 billion of credit. Banks were allowed
to turn their bad mortgage loans and other loans over to the Federal Reserve at
par value (rather at just 20 percent 'mark to market' prices). The Fed's cover
story is that this infusion will enable the banks to resume lending to 'get the
economy moving again.' But the banks are using the money to bet against the
dollar. They are borrowing from the Fed at a low interest rate, and buying
foreign euro-denominated bonds yielding a higher interest rate -- and in the
process, making a currency gain as the euro rises against dollar-denominated
assets. The Fed thus is subsidizing capital flight, exacerbating inflation by making
the price of imports (headed by oil and other raw materials) more expensive.
These commodities are not more expensive to European buyers, but only to buyers
paying in depreciated dollars."
The banksters are "buying foreign euro-denominated
bonds" during an economic crisis in America? Whoa. Now there's an
interesting take on patriotism.
The Fed's strategy has even failed to lower mortgage rates
which are pinned to the 30-year Treasury and which has actually gone up since
Bernanke began slashing rates. This inability to pass on the Fed's rate cuts to
potential mortgage applicants ensures that the housing meltdown will continue
unabated well into 2009 and, perhaps, 2010.
In the last few days, the Fed has provided $30 billion to
buy up the least-liquid speculative debts of a privately-owned investment bank
Bear Stearns, which was leveraged at 32 to 1 and which will remain unsupervised
by federal regulators. How does that address the underlying issues of the
credit crunch? Are Bernanke and Paulson really trying to put the financial
markets back on solid footing again or are they merely expressing their
That question was answered in an article last
Tuesday in the Wall Street Journal which explained the real reasons
behind the Bear bailout: "The illusion was shattered Saturday morning,
when Mr. Paulson was deluged by calls to his home from bank chief executives.
They told him they worried the run on Bear would spread to other financial
institutions. After several such calls, Mr. Paulson realized the Fed and
Treasury had to get the J.P. Morgan deal done before the markets in Asia opened
on late Sunday, New York time.
"'It was just clear that this franchise was going to
unravel if the deal wasn't done by the end of the weekend,' Mr. Paulson said in
an interview yesterday. " ["The Week that Shook Wall Street",
Wall Street Journal]
So all it took was a little nudge from his
banking cohorts for Paulson to swing into action and firm up the
deal. That says it all. The interests of the American people were
never even considered. It was all choreographed to bail out the
financial industry. No wonder so many people believe that the Federal
Reserve and the US Treasury are merely an extension of the banking
establishment. The Bear bailout proves it.
Whitney lives in Washington state. He can be reached at firstname.lastname@example.org.