Stock market brushfire; will there be a run on the banks?
By Mike Whitney
Online Journal Contributing Writer
Aug 15, 2007, 01:35
On Friday, the Dow Jones clawed its way back from a
200-point deficit to a mere 31-point loss after the Federal Reserve injected
$38 billion into the banking system. The Fed had already pumped $24 billion
into the system a day earlier after the Dow plummeted 387 points. That brings
the Fed�s total commitment to a whopping $62 billion.
By some estimates, $326.3 billion has now been added to the
G-7 Nations� intra-banking system to prevent a breakdown. That amount will
steadily rise in the weeks ahead as the situation continues to deteriorate.
Some readers may remember that on Tuesday, August 7, the Fed announced that it
was NOT planning to bail out the market.
My, how quickly things change.
So far, the economic pundits and CEOs have applauded the
Fed�s intervention as a �constructive� way of staving off an impending credit
Are these the same �experts� who always sing the praises of
unregulated �free markets� while condemning any government intervention?
The investment banks and fund mangers love �free markets�
when it means eliminating the rules that prevent them from gaming the system.
But they don�t like it so much when their shabby Ponzi-rackets start to
unravel. Then they�re the first in line to beg for a bailout.
That�s what�s happening right now. The Fed is keeping the
stock market afloat by increasing liquidity at the banks. If it wasn�t for
Bernanke�s billions of dollars of low interest credit -- the banking system and
stock market would collapse in a heap. The Fed�s �not-so-invisible hand� is the
only thing holding the whole dilapidated system in place.
Is that the way it�s supposed to work in a free market
system -- with the Fed acting as the nation�s Economic Central Planner
intervening whenever it suits the interests of its wealthiest constituents?
Sounds more like a Financial Politburo, doesn�t it?
In truth, the �free market� means nothing to the men who run
the system. It�s just a public relations scam designed to dupe investors into
plunking their money into a system that�s rigged for the carnivores at the top
of the economic food chain.
Does anyone really believe that the market commissars would
allow the system to operate according to the arbitrary swings in investor
confidence and random speculation?
This is THEIR SYSTEM and they run it THEIR WAY. The only
time that changes is when their twisted schemes go haywire and they need a
handout from the taxpayer. In the present case, they are asking Big Brother
Bernanke to bail them out on trillions of dollars of non-performing subprime
garbage loans, which masquerade as securities in the secondary market. The Fed
has already indicated that it will do whatever it can to help.
But what good will it do?
The banks are currently holding (roughly) $300 billion in
collateralized debt obligations (CDOs) and another $225 billion in
collateralized loan obligations (CLOs) More than one-half trillion dollars in
debt which is essentially �illiquid� and has no clear market value. It could be
worthless for all we know.
That hasn�t stopped the Fed riding to the rescue, buying up
many of these toxic CDOs and increasing banking reserves so the great
fractional banking con game can continue unabated. This is what one astute
observer called �alchemy finance.�
Central banks around the world have opened up the liquidity
spigots to avoid a global credit meltdown. But their efforts are bound to fail.
The banks are sitting on huge losses from assets that they can�t move through
the pipeline and which have gobbled up their reserves. Bloomberg News summed it
up like this: �The $2 trillion market for mortgages not backed by
government-sponsored agencies is at a standstill.�
The same is true of the corporate bond market. As the Wall
Street Journal reported last week: �The investment grade corporate bond market
has ground to a halt, making it difficult for companies to access capital and
hard for investors to find a place to put their money to work. . . . .The
problems in the primary market could, if they persist, throw a wrench in the
workings of corporate America, making it tougher for companies to finance,
among other things, investments, buyouts and equity buybacks. . . . For July,
corporate bond issuance was down 77 percent from June.� (�Corporate Bond Market
has come to a Standstill,� Wall Street Journal)
The mighty wheels of commerce have rusted in place. Nothing
is moving. Trillions of dollars of poisonous CDOs need to unwind, but the banks
cannot put them up for bid for fear that they�ll only get pennies on the
dollar. It�s like watching a slow-motion train wreck. The Fed�s cheap credit
won�t help either. At best, it�ll just buy a little time before the true value
of these bonds is established and trillions of dollars in market capitalization
vanish into cyberspace. Banks, equities, hedge funds, insurance companies and
pension funds are all in line to suffer major losses.
Last week BNP Paribas suspended three funds because they
couldn�t get bids on the CDOs they own. When securities have no fixed market
value; who is going to buy them?
No one. Besides being complex and opaque, real estate CDOs
have become the global pariah -- �leper equities� that no one will touch.
That�s why no transactions are taking place and the system is
freezing up. If Paribas shuttered its doors, there must be many other funds
The Federal Reserve started this mess by lowering interest
rates to 1 percent and flushing trillions of dollars into the economy. That
cheap money created equity-bubbles in housing, credit, stocks and bonds which
are now beginning to unwind. Expanding the money supply might be a good
short-term fix, but it�s dangerous, too. It just adds hyperinflation to the
long list of existing problems.
The volatility in the stock market has diverted attention
from the problems facing the banking system. The banks have been originating
loans and bundling them off to Wall Street to avoid the normal reserve
requirements. Now they�ve been �caught short� and don�t have adequate funding
to cover their bets. If the Fed doesn�t help out, we�ll see at least one or two
major bank closures.
This is a story that won�t appear in the media. Bank-runs
are the beginning of the end -- financial Armageddon.
The problems facing the stock market are serious but not
catastrophic. If the market corrects more than 10 or 15 percent, the massive
overleveraged hedge fund industry will cave in taking (potentially) $1.7
trillion down a black hole. This may explain why the market has behaved so
erratically lately. There have been several late-day rallies with no good news
to support the soaring equities prices. Is the market being micro-managed
behind the scenes to keep it above a certain level?
Many people think so. A number of articles have been written
recently about the activities of the Plunge Protection Team, the secretive
group (comprised of the SEC, US Treasury, Federal Reserve, and Investment
Banks) which allegedly buys futures to forestall violent sell-offs in the
market. The Fed�s desperate infusions of credit into the banking system will
only reinforce growing suspicions of market manipulation.
Banks routinely hedge against adverse moves in the market by
purchasing various types of insurance in the form of derivatives contracts.
Derivatives trading has skyrocketed in the last few years and the �British
Bankers Association estimated last fall that by the end of 2006, the market for
all credit derivatives was $20 trillion and expected to be $33 trillion by the
end of 2008.�These relatively new instruments are about to be put to the test
by worsening market conditions.
�Hedge funds may account for as much as 30 percent of such
credit protection� but that is little solace for the banks �because hedge funds
that are losing money but also selling credit insurance may not be able to
honor their commitments, rendering the protection worthless.� (�Insuring
against Credit Risk can carry risks of its own,� Henny Sender, Wall Street
Credit insurance in the form of credit default swaps have
created a false sense of security that may prove to be unfounded. In fact, the
credit insurance business has probably encouraged lenders to make shakier and
shakier loans believing that they were protected from risk. But that doesn�t
appear to be the case. For example, Bear Stearns tried to soothe investor�s
fears during the collapse of its two hedge funds by pointing to its derivatives
�Bear executives repeatedly referred to their dependence on
hedges, including credit derivatives, to offset their losses on subprime
mortgages and loans to poorly rated companies, stating that such hedges would
offset losses.� (Ibid, H. Sender, Wall Street Journal)
We all know how that story ended up.
Derivatives have been celebrated as a critical part of the
�new architecture of the financial markets.� Now we can see that they are
poor-performers under real-life conditions and liable to trigger an even
greater disaster. If the stock market stumbles, we can expect a major breakdown
in credit insurance trading with trillions of dollars in derivatives
The abstruse world of derivatives trading will suddenly
explode onto the headlines of newspapers across the country.
Housing brushfire sweeps through the economy
The contamination from the massive real estate bubble has
now infected nearly every area of the broader market. The swindle which began
at the Federal Reserve -- with cheap, low interest credit -- has spread through
the entire system and is threatening to wreak financial havoc across the
planet. The Fed�s multi-billion dollar bailout will do nothing to contain the
brushfire they started or avert the catastrophe that lies ahead. Greenspan
opened Pandora�s Box and we�ll all have to live with the consequences.
Whitney lives in Washington state. He can be reached at firstname.lastname@example.org.
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