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America's teetering banking
system
Mike Whitney
Online
Journal
Friday February 1, 2008
Somebody goofed. When Fed chairman Ben Bernanke
cut interest rates to 3 percent Wednesday, the price of a new
mortgage went up. How does that help the flagging housing industry?
About an hour after Bernanke made the announcement that the Fed
Funds rate would be cut by 50 basis points, the yield on the 30-year
Treasury nudged up a tenth of a percent to 4.42 percent. The same
thing happened to the 10-year Treasury which surged from a low
of 3.28 percent to 3.73 percent in less than a week. That means
that mortgages, which are priced off long-term government bonds,
will be going up, too.
Is that what Bernanke had in mind, to stick another dagger into
the already-moribund real estate market?
The Fed sets short-term interest rates (The Fed Funds rate) but
long-term rates are market-driven. So, when investors see slow
growth and inflationary pressures building up, long-term rates
start to rise. That's bad news for the housing market.
(Article continues below)
Now, here's the shocker: Bernanke knew that the price of a mortgage
would increase if he slashed rates, but went ahead anyway.
How did he know?
Because nine days ago, when he cut rates by 75 basis points,
the 10-year didn't budge from its perch at 3.64 percent. It just
shrugged it off the cuts as meaningless. But a couple days later,
when the House passed Bush's $150 billion "Stimulus Giveaway,"
the 10-year spiked with a vengeance -- up 20 basis points on the
day. In other words, the bond market doesn't like inflation-generating
government handouts.
So, why did Bernanke cut rates when he knew it would just add
to the housing woes?
Some critics say that he just wanted to throw a lifeline to his
fat-cat investor buddies on Wall Street by providing more liquidity
for the markets. But that's not it, at all. The fact is Bernanke
had no choice. He's facing a challenge so huge and potentially
catastrophic that cutting rates must have seemed like the only
option he had. Just 1ook at these graphs and you'll see what Bernanke
saw before he decided to cut interest rates.
Negative bank reserves
The banks are busted.
The first graph (Total Borrowings of Depository Institutions
from the Federal Reserve) shows that the banks are capital impaired
and borrowing at a rate unprecedented in history.
The second graph (Non-Borrowed Reserves of Depository Institutions)
shows that the capital that the banks do have is quickly being
depleted.
The third graph (Net Free or Borrowed Reserves of Depository
Institutions) is best summed up by econo-blogger Mike Shedlock
who says, "Banks in aggregate have now burnt through all
of their capital and are forced to borrow reserves from the Fed
in order to keep lending. Total reserves for two weeks ending
January 16 are $39.98 billion. Inquiring minds are no doubt wondering
where $40 billion came from. The answer is the Fed's Term Auction
Facility." [Mish's Global Economic Trend Analysis] So the
only reserves they have is capital they borrowed from the Fed.
The forth Fed graph illustrates the steep trajectory of the ever-expanding
money supply. (Monetary Base).
A careful review of these graphs should convince even the most
hardened skeptic that the banking system is basically underwater
and insolvent. We are entering uncharted waters. The sudden and
shocking depletion of bank reserves is due to the huge losses
inflicted by the meltdown in subprime loans and other similarly
structured investments.
How capital is destroyed
When US homeowners default on their mortgages en masse, they
destroy money faster than the Fed can replace it through normal
channels. The result is a liquidity crisis which deflates asset
prices and reduces monetized wealth, says economist Henry Liu.
The debt-securitization process is in a state of collapse. The
market for structured investments -- MBSes, CDOs, and Commercial
Paper -- has evaporated leaving the banks with astronomical losses.
They are incapable of rolling over their short-term debt or finding
new revenue streams to buoy them through the hard times ahead.
As the foreclosure avalanche intensifies; bank collateral continues
to be downgraded which is likely to trigger a wave of bank failures.
Henry Liu sums it up like this: "Proposed government plans
to bail out distressed home owners can slow down the destruction
of money, but it would shift the destruction of money as expressed
by falling home prices to the destruction of wealth through inflation
masking falling home value." [The Road to Hyperinflation,
Henry Liu, Asia Times] It's a vicious cycle. The Fed is caught
between the dual millstones of hyperinflation and mass defaults.
There's no way out.
The pace at which money is currently being destroyed will greatly
accelerate as trillions of dollars in derivatives are consumed
in the flames of a falling market. As GDP shrinks from diminishing
liquidity, the Fed will have to create more credit and the government
will have to provide more fiscal stimulus. But in a deflationary
environment; public attitudes towards spending quickly change
and the pool of worthy loan applicants dries up. Even at 0 percent
interest rates, Bernanke will be stymied by the unwillingness
of undercapitalized banks to lend or overextended consumers to
borrow. He'll be frustrated in his effort to restart the sluggish
consumer economy or stop the downward spiral. In fact, the slowdown
has already begun and the trend is probably irreversible.
The financial markets are deteriorating at a faster pace than
anyone could have imagined. Mega-billion dollar private equity
deals have either been shelved or are unable to refinance. Asset-backed
Commercial Paper (short-term notes backed by sketchy mortgage-backed
collateral) has shrunk by $400 billion (one-third) since August.
Also, the market for corporate bonds has fallen off a cliff in
a matter of months. According to the Wall Street Journal, a paltry
$850 million in high-yield debt has been issued for January, while
in January 2007 that figure was $8.5 billion -- 10 times bigger.
That's a hefty loss of revenue for the banks. How will they make
it up?
Judging by the Fed's graphs, they won't!
Bernanke's rate cuts sent stocks climbing on Wall Street, but
by early Wednesday afternoon the rally fizzled on news that Financial
Guaranty, one of the nation's biggest bond insurers, would be
downgraded. The Dow lost 37 points by the closing bell.
"MBIA Inc, the world's largest bond insurer, posted its
biggest-ever quarterly loss and said it is considering new ways
to raise capital after a slump in the value of subprime-mortgage
securities the company guarantee. The insurer lost $2.3 billion
in the fourth-quarter. Its downgrading from AAA will cripple its
business and throw ratings on $652 billion of debt into doubt.
Many of the investment banks have assets that will get a haircut,"
according to Bloomberg.
The New York State Insurance Department tried to work out a bailout
plan but the banks could not agree on the terms [ed note: They
don't have the money.]
"Bond insurers guarantee $2.4 trillion of debt combined
and are sitting on losses of as much as $41 billion, according
to JPMorgan Chase & Co. analysts. Their downgrades could force
banks to write down $70 billion, Oppenheimer & Co. analyst
Meredith Whitney said Wednesday in a report." [Bloomberg]
"The bond insurers were working the same scam as the investment
banks. They found a loophole in the law that allowed them to deal
in the risky world of derivatives; and they dove in headfirst.
They set up shell companies called transformers, (The same way
the investment banks established SIVs, structured Investment Vehicles)
which they used as off balance sheets operations where they sold
'credit default swaps,' which are derivative instruments where
one party, for a fee, assumes the risk that a bond or loan will
go bad." [The Bond Transformers, Wall Street Journal] The
bond insurers have written about $100 billion of these swaps in
the last few years. Now they're all blowing up at once.
"Credit default swaps (CDS) have turned out to be a goldmine
for the bond insurers and they've given a boost to the banks too,
by freeing up capital to use in other ventures. The banks profited
on the interest rate difference between the CDOs (collateralized
debt obligations) they bought and the payments they made to transformers
. . . The banks sometimes booked profits upfront on the streams
of income they expected to receive." [WSJ]
Neat trick, eh? Who wouldn't want to enjoy the profit from a
job before they've done a lick of work?
Even now that the whole swindle is beginning to unravel -- and
tens of billions of dollars are headed for the shredder -- industry
spokesmen still praise credit default swaps as financial innovation.
Go figure?
Politicians still getting their marching orders from Wall Street
The leaders of Europe's four largest economies (England, France,
Germany, Italy) held a meeting this week where they discussed
better ways to monitor the world's markets and banks. They did
not, however, push to create a new regime of oversight, regulation
and punitive action that would be directed at financial fraudsters
and their structured Ponzi scams. Politicians love to talk about
greater transparency and watchdog agencies, but they have no stomach
for establishing the hard-fast rules and independent policing
organizations that are required to keep the carpetbaggers and
financial hucksters from duping gullible investors out of their
life savings. That is simply beyond their pay grade. And that
is why even now -- when the world is facing the most serious financial
crisis since the Great Depression -- corporate toadies like British
Prime Minister Gordon Brown merely reiterate the script prepared
for them by their boardroom paymasters: "If these agencies
don't reform themselves, the Europeans would turn to regulatory
response to enforce change."
Right-o, Gordon. Right-o.
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