'Even Experts Can't Grasp This Crisis'
'The Collapse Of American Power'
'America Was Conned - Who Will Pay?'
'A Financial Crisis Unmatched Since The Great Depression, Say Analysts'
'Analysis: U.S. Eonomy In Crisis As It Pays Price For Greed'
'Bear Stearns Fire-sale Sends Global Markets Plunging; Dollar Routed'
'Wall Street Fears For Next Great Depression'
'Billionaire Lewis Moves To Block JP Morgan'
'Venezuela's State-Run Oil Company Begins Demanding Payment In Euros
As U.S. Dollar Weakens'
'Foreign Investors Veto Fed Rescue'
- Deflation And Curreny Debasement To Go Global?
'The Dollar's Depreciation To Persist'
'Lehman Sees Risk Of Double-Dip U.S. Recession'
'Five Years Of A Disastrous War And The Bills Are Coming Due'
'U.S. Crashes - China Breaks'
Editorial: 'U.S. Financial Crisis'
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 our 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 yesterday; their plan must have succeeded.
The Plunge Protection Team is a panel that includes Fed Chairman Ben Bernanke, 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 over-leveraged banking system from its inevitable Day of Reckoning. And, yet, that appears to be the reason for the White House confab.
The psychology behind the PPT's activities are 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' rushes in to join in the buying madness for several days and weeks as the rally gathers a life of its own. (Robert McHugh Ph.D., "The Plunge Protection Team Indicator")
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 wherever it likes; is pure rubbish. The Fed has very defined 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 arsenal:
"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; 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 and stalling a system-wide collapse. It just means, that markets will eventually correct regardless of what anyone does. 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 re-commitment to transparency, rather than the "business as usual" deception of the public that keeps the balls in the air for another day or two.
"Sucker rallies", like yesterday's 400 point surge on Wall Street just obfuscate the systemic problems that need to be addressed before investor confidence is restored. Blogger Rick Ackerman summed it up succinctly in last night's entry:
"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." (Rik's Piks Rick Ackerman)
Whether Ackerman's dire predictions materialize or not, there's no denying that the situation is getting worse by the day. In just the last week, 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 increase the rate of the deflation adding to the already-prodigious losses from housing foreclosures, delinquent credit card debt, defaulting car loans, and the accelerating 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," Mr. Bush opined on Monday after meeting with his top economic aides. "But we are on top of the situation".
That's comforting. Bush is all over it.
Yesterday's 75 basis point rate cut by the Fed is a further sign of desperation. The Fed Funds rate is now 2 percentage points below the rate of inflation; a obvious attempt on Bernanke to reflate the equity bubble at the expense of the dollar. Is that why Wall Street was so happy; 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 few quarters.
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 developments carefully.
Today's policy 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, on Tuesday, the battered investment banks began posting first quarter earnings which were better than expected. Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. beat estimates which added to the giddiness at the NYSE. Unfortunately, a careful reading of the reports, shows that things are not as they seem. The jubilation is unwarranted; it's just more smoke and mirrors.
"Lehman Brothers Holdings Inc. reported a 57% 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% 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. 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 titan 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. Economic's analyst, Mark Gongloff, has compiled some interesting figures 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."
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 making a big mistake by protecting them from the consequences of their speculative excesses. As hyper-inflated assets continue to lose altitude, and structured investments and arcane hedges against default begin to disintegrate; these wastrel institutions will be crushed by a stampede of panicking investors running for the exits. The flight to safety has already begun. Cash is king.
Look what has transpired just since Monday.
"Crude oil, copper and coffee led a decline in commodities that may be the biggest ever recorded on speculation that a U.S. recession will stall demand for raw materials." (Bloomberg) Yes, all asset classes fall in a deflationary spiral even commodities which many people believe are a safe bet. Not so. In fact, even gold has begun to retreat as hedge funds and other market participants are forced to relinquish their positions.
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."
Again, the "flight to safety" as investors recognize the warning signs of deflation. This trend will further 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 to understanding the gravity of what is really going on. The Fed's rate cuts are not affecting the lending between banks which is actually deteriorating quite rapidly. And, 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, so there must be traffic between the major lending institutions. The banks are hoarding cash to cover losses on their steadily downgraded mortgage-backed assets and to shore up their skimpy capital reserves. As a result, consumer spending will slow, housing will continue to falter, business will contract and GDP will shrink.
"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. "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."
But Paulson is clearly out of his depth. He's just not the man to deal with a crisis of this magnitude. His only interest is bailing out his 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 lost not only their jobs but the entire retirement 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 reenergizing consumer spending. But that won't 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" (counterpunch.org) the banks are making no attempt to stimulate the economy, but simply turn a profit with capital borrowed from the Fed:
"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% "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 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 business, 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 bank-centered cultural bias?
That question was answered in an article on Tuesday by the Wall Street Journal which offered this explanation of the real reasons behind the Bear bailout:
"That 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)
Ah-ha! So all it took was a little nudge from his banking buddies to put Paulson over the top.
The Bear bailout was engineered to serve the needs of the banking establishment; nothing more. The Federal Reserve and the US Treasury are merely an extension of the financial industry. The Bear bailout proves it.
Raise your hand if you don't quite understand this whole financial crisis.
It has been going on for seven months now, and many people probably feel as if they should understand it. But they don't, not really. The part about the housing crash seems simple enough. With banks whispering sweet encouragement, people bought homes they couldn't afford, and now they are falling behind on their mortgages.
But the overwhelming majority of homeowners are still doing just fine. So how is it that a mess concentrated in one part of the mortgage business - subprime loans - has frozen the credit markets, sent stock markets gyrating, caused the collapse of Bear Stearns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression?
I'm here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis.
"We're exposing parts of the capital markets that most of us had never heard of," Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former Treasury secretary and current Citigroup executive, has said that he hadn't heard of "liquidity puts," an obscure kind of financial contract, until they started causing big problems for Citigroup.
I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, "Can you try to explain this to me?" When they finished, I often had a highly sophisticated follow-up question: "Can you try again?"
I emerged thinking that all the uncertainty has created a panic that is partly unfounded. That said, the crisis isn't close to ending, either. Ben Bernanke, the Federal Reserve chairman, won't be able to wave a magic wand and make everything better, no matter how many more times he cuts rates. As Bernanke himself has suggested, the only thing that will end the crisis is the end of the housing bust.
So let's go back to the beginning of the boom.
It really started in 1998, when large numbers of people decided that real estate, which still hadn't recovered from the early 1990s slump, had become a bargain. At the same time, Wall Street was making it easier for buyers to get loans. It was transforming the mortgage business from a local one, centered around banks, to a global one, in which investors from almost anywhere could pool money to lend.
The new competition brought down mortgage fees and spurred some useful innovation. Why, after all, should someone who knows that she's going to move after just a few years have no choice but to take out a 30-year fixed-rate mortgage?
As is often the case with innovations, though, there was soon too much of a good thing. Those same global investors, flush with cash from Asia's boom or rising oil prices, demanded good returns. Wall Street had an answer: subprime mortgages.
Because these loans go to people stretching to afford a house, they come with higher interest rates - even if they're disguised by low initial rates - and higher returns. The mortgages were then sliced into pieces and bundled into investments, often known as collateralized debt obligations, or CDO's (a term that appeared in this newspaper only three times before 2005, but every week since last summer). Once bundled, different types of mortgages could be sold to different groups of investors.
Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money. Home buyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody's Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years.
All these investments, of course, were highly risky. Higher returns almost always come with greater risk. But people - by "people," I'm referring here to Greenspan, Bernanke, the top executives of almost every Wall Street firm and a majority of American homeowners - decided that the usual rules didn't apply because home prices nationwide had never fallen before. Based on that idea, prices rose ever higher, so high, says Robert Barbera of ITG, an investment firm, that they were destined to fall. It was a self-defeating prophecy.
And it largely explains why the mortgage mess has had such ripple effects. The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it. Last summer, many policy makers were hoping that the crisis wouldn't spread to traditional banks, like Citibank, because they had sold off the underlying mortgages to investors. But it turned out that many banks had also sold complex insurance policies on the mortgage debt. That left them on the hook when homeowners who had taken out a wishful-thinking mortgage could no longer get out of it by flipping their house for a profit.
Many of these bets were not huge, but were so highly leveraged that any losses became magnified. If that $100 million investment I described above were to lose just $1 million of its value, the investor who put up only $1 million would lose everything. That's why a hedge fund associated with the prestigious Carlyle Group collapsed last week.
"If anything goes awry, these dominos fall very fast," said Charles Morris, a former banker who tells the story of the crisis in a new book, "The Trillion Dollar Meltdown."
This toxic combination - the ubiquity of bad investments and their potential to mushroom - has shocked Wall Street into a state of deep conservatism. The soundness of any investment firm depends largely on other firms having confidence that it has real assets standing behind its bets. So firms are now hoarding cash instead of lending it, until they understand how bad the housing crash will become and how exposed to it they are. Any institution that seems to have a high-risk portfolio, regardless of whether it has enough assets to support the portfolio, faces the double whammy of investors demanding their money back and lenders shutting the door in their face. Goodbye, Bear Stearns.
The conservatism has gone so far that it's affecting many solid would-be borrowers, which, in turn, is hurting the broader economy and aggravating Wall Streets fears. A recession could cause credit card loans and others, some of which were also based on overexuberance, to start going bad, as well.
Many economists, on the right and the left, now argue that the only solution is for the federal government to step in and buy some of the unwanted debt, as the Fed began doing last weekend. This is called a bailout, and there is no doubt that giving a handout to Wall Street lenders or foolish home buyers - as opposed to, say, laid-off factory workers - is deeply distasteful. At this point, though, the alternative may, in fact, be worse.
Bubbles lead to busts. Busts lead to panics. And panics can lead to long, deep economic downturns, which is why the Fed has been taking unprecedented actions to restore confidence.
"You say, my goodness, how could subprime mortgage loans take out the whole global financial system?" Zandi said. "That's how."
In his famous book, The Collapse of British Power (1972), Correlli Barnett reports that in the opening days of World War II Great Britain only had enough gold and foreign exchange to finance war expenditures for a few months. The British turned to the Americans to finance their ability to wage war. Barnett writes that this dependency signaled the end of British power.
From their inception, America's 21st century wars against Afghanistan and Iraq have been red ink wars financed by foreigners, principally the Chinese and Japanese, who purchase the US Treasury bonds that the US government issues to finance its red ink budgets.
The Bush administration forecasts a $410 billion federal budget deficit for this year, an indication that, as the US saving rate is approximately zero, the US is not only dependent on foreigners to finance its wars but also dependent on foreigners to finance part of the US government's domestic expenditures. Foreign borrowing is paying US government salaries--perhaps that of the President himself--or funding the expenditures of the various cabinet departments. Financially, the US is not an independent country.
The Bush administration's $410 billion deficit forecast is based on the unrealistic assumption of 2.7% GDP growth in 2008, whereas in actual fact the US economy has fallen into a recession that could be severe. There will be no 2.7% growth, and the actual deficit will be substantially larger than $410 billion.
Just as the government's budget is in disarray, so is the US dollar which continues to decline in value in relation to other currencies. The dollar is under pressure not only from budget deficits, but also from very large trade deficits and from inflation expectations resulting from the Federal Reserve's effort to stabilize the very troubled financial system with large injections of liquidity.
A troubled currency and financial system and large budget and trade deficits do not present an attractive face to creditors. Yet Washington in its hubris seems to believe that the US can forever rely on the Chinese, Japanese and Saudis to finance America's life beyond its means. Imagine the shock when the day arrives that a US Treasury auction of new debt instruments is not fully subscribed.
The US has squandered $500 billion dollars on a war that serves no American purpose. Moreover, the $500 billion is only the out-of-pocket costs. It does not include the replacement cost of the destroyed equipment, the future costs of care for veterans, the cost of the interests on the loans that have financed the war, or the lost US GDP from diverting scarce resources to war. Experts who are not part of the government's spin machine estimate the cost of the Iraq war to be as much as $3 trillion.
The Republican candidate for President said he would be content to continue the war for 100 years. With what resources? When America's creditors consider our behavior they see total fiscal irresponsibility. They see a deluded country that acts as if it is a privilege for foreigners to lend to it, and a deluded country that believes that foreigners will continue to accumulate US debt until the end of time.
The fact of the matter is that the US is bankrupt. David M. Walker, Comptroller General of the US and head of the Government Accountability Office, in his December 17, 2007, report to the US Congress on the financial statements of the US government noted that "the federal government did not maintain effective internal control over financial reporting (including safeguarding assets) and compliance with significant laws and regulations as of September 30, 2007." In everyday language, the US government cannot pass an audit.
Moreover, the GAO report pointed out that the accrued liabilities of the federal government "totaled approximately $53 trillion as of September 30, 2007." No funds have been set aside against this mind boggling liability.
Just so the reader understands, $53 trillion is $53,000 billion.
Frustrated by speaking to deaf ears, Walker recently resigned as head of the Government Accountability Office.
As of March 17, 2008, one Swiss franc is worth more than $1 dollar. In 1970, the exchange rate was 4.2 Swiss francs to the dollar. In 1970, $1 purchased 360 Japanese yen. Today $1 dollar purchases less than 100 yen.
If you were a creditor, would you want to hold debt in a currency that has such a poor record against the currency of a small island country that was nuked and defeated in WW II, or against a small landlocked European country that clings to its independence and is not a member of the EU?
Would you want to hold the debt of a country whose imports exceed its industrial production? According to the latest US statistics as reported in the February 28 issue of Manufacturing and Technology News, in 2007 imports were 14 percent of US GDP and US manufacturing comprised 12% of US GDP. A country whose imports exceed its industrial production cannot close its trade deficit by exporting more.
The dollar has even collapsed in value against the euro, the currency of a make-believe country that does not exist: the European Union. France, Germany, Italy, England and the other members of the EU still exist as sovereign nations. England even retains its own currency. Yet the euro hits new highs daily against the dollar.
Noam Chomsky recently wrote that America thinks that it owns the world. That is definitely the view of the neoconized Bush administration. But the fact of the matter is that the US owes the world. The US "superpower" cannot even finance its own domestic operations, much less its gratuitous wars except via the kindness of foreigners to lend it money that cannot be repaid.
The US will never repay the loans. The American economy has been devastated by offshoring, by foreign competition, and by the importation of foreigners on work visas, while it holds to a free trade ideology that benefits corporate fat cats and shareholders at the expense of American labor. The dollar is failing in its role as reserve currency and will soon be abandoned.
When the dollar ceases to be the reserve currency, the US will no longer be able to pay its bills by borrowing more from foreigners.
I sometimes wonder if the bankrupt "superpower" will be able to scrape together the resources to bring home the troops stationed in its hundreds of bases overseas, or whether they will just be abandoned.
Paul Craig Roberts was Assistant Secretary of the Treasury during President Reagan's first term. He was Associate Editor of the Wall Street Journal. He has held numerous academic appointments, including the William E. Simon Chair, Center for Strategic and International Studies, Georgetown University, and Senior Research Fellow, Hoover Institution, Stanford University. He was awarded the Legion of Honor by French President Francois Mitterrand.
Bear Stearns marks the moment when the global financial crisis went critical. Up until last Friday, it had been possible - just about - to believe that the worst was over and that things were about to get better. That pretence was stripped away when JP Morgan, at the behest of the Federal Reserve, stepped in when the hedge funds pulled the plug on the fifth-biggest US investment bank.
It is now clear that no end is in sight to the turmoil, and the reason for that is that the Fed and the US treasury are no closer to solving the underlying problem than they were eight months ago. The crisis will only end when house prices stop falling and banks stop racking up huge losses on their loans. Doing that, however, will require the US government to intervene directly in the real estate market to end the wave of foreclosures. Ideologically, it is ill-equipped to take that step and, as a result, property prices will fall and the financial meltdown will go on and on.
Ultimately, though, action will be taken because there will be political pressure for it. Indeed, it is somewhat surprising that there is not already rioting in the streets, given the gigantic fraud perpetrated by the financial elite at the expense of ordinary Americans.
The US has just had its weakest period of expansion since the 1950s. Consumption growth has been poor. Investment growth has been modest. Exports have been sluggish. But if you are at the top of the tree, the years since the last recession in 2001 has been a veritable golden age. Salaries for executives have rocketed and profits have soared, because the productivity gains from a growing economy have been disproportionately skewed towards capital.
Patriotic
For ordinary Americans, though, it has been a different story. Real wages have been growing slowly; at just 1.6% a year on average over the latest upswing, well down on the experience of earlier decades. Business, of course, needs consumers to carry on spending in order to make money, so a way had to be found to persuade households to do their patriotic duty. The method chosen was simple. Whip up a colossal housing bubble, convince consumers that it makes sense to borrow money against the rising value of their homes to supplement their meagre real wage growth and watch the profits roll in.
As they did - for a while. Now it's payback time and the mood could get very ugly. Americans, to put it bluntly, have been conned. They have been duped by a bunch of serpent-tongued hucksters who packed up the wagon and made it across the county line before a lynch mob could be formed.
The debate now is not about whether the US is in recession but how deep and long that recession will be. Super-bears have started to say that this is perhaps "The Big One", by which they mean the onset of a new Great Depression. The need to rescue Bear Stearns has done little to still those voices.
As the economics team at HSBC recently pointed out, there has been a "catastrophic breakdown" of trust, and when that has happened in the past - the US in the 1930s, Japan in the 1990s - chucking extra money at the banks in the hope that they will start lending again proves ineffective.
It's not hard to see why trust has become such a rare commodity: Wall Street at the height of the securitisation mania had, in effect, become London at the time of the South Sea Bubble crisis in 1720. Vast quantities of funny paper were changing hands even though those involved in the deals had no idea of their true worth. Nor did they care. Inevitably, now the bubble has burst and the huge Ponzi securitisation scam has been exposed, there has been a reaction. The securitisation market is dead, there is less money sloshing round the system, banks are hoarding their cash.
Having allowed the housing boom to rage out of control for too long and then delaying cuts in interest rates until the housing market was gripped by recessionary forces, the Fed is now trying to make up for lost time with a burst of hyperactivity. It will cut interest rates on Wednesday and keep cutting them: financial markets expect the Fed funds rate to be 1% by the summer, and they are probably right. In most downturns, easier monetary policy does the trick. Lower interest rates make it cheaper to borrow and also change the trade-off between saving and spending. This may not be the usual sort of downturn, however, with consumers going through a period of debt revulsion after the excesses of recent years, even so the consensus is that after two or three quarters of falling output, a slow and sluggish recovery will be under way.
Deflation
These hopes are likely to be dashed, unless there is intervention at home and internationally to tackle the crisis. Domestically, the priority should be to stop homes that have been foreclosed being auctioned on the open market, since by selling them at a 50% discount property prices are driven down. The US does not seem to have learned the lessons from Japan, which encouraged a fire sale of property in the 1990s and was sucked into a classic debt deflation trap as a result. Those who argue, with some force, that it would be counter-productive to intervene in the market because the US needs to work the rottenness out of its system must recognise that the cold turkey option will be very long and painful.
The second form of intervention should be to shore up the dollar, the collapse of which is worrying countries that rely heavily on exports and is the main reason for the surge in commodity prices. Co-ordinated intervention by the major central banks needs to be at the top of the agenda at next month's G7 meeting in Washington, and there could be action even sooner if the dollar continues to tank.
In the longer term, lessons must be learnt from the turmoil. One is that you don't solve the problems of a collapsing bubble by blowing up another, which is what Alan Greenspan did after the dotcom fiasco in 2001 - the most irresponsible behaviour of any central banker in living memory.
The second lesson is that there has to be far stricter regulation not just of the US real estate market but of Wall Street, to prevent the return of irresponsible lending as soon as the recovery is firmly under way. If this is, heaven help us, The Big One, one of the only consolations will be that the repugnance at the orgy of speculation that has sapped the strength of the US economy will put a new New Deal on the political agenda.
But for this to happen there has to be a political response and even though this year's presidential election will be held in the shadow of recession, there appears not to be a potential FDR among the contenders for the White House. Yet if this crisis really does get as bad as some are forecasting, the public will rightly demand more than a slap on the wrist for Wall Street.
A century after John Pierpont Morgan rescued the New York stockmarket from a 50% sell off in share prices, his blue-blooded Wall Street bank was yesterday once again at the heart of attempts to contain the deepening global financial crisis.
In an echo of the "bankers' panic" of 1907, JP Morgan responded to what is being billed as a meltdown of historic proportions by agreeing to buy its stricken rival, Bear Stearns.
The length and severity of the crisis that broke over global markets last summer has had analysts delving into their history books. George Soros, who was largely responsible for Black Wednesday, the last bout of serious financial turmoil to afflict the UK, believes there has been nothing to match the events of the past nine months since the Great Depression.
Alan Greenspan, the former chairman of the Fed and the man blamed by many for setting off the boom-bust in the US housing market, agrees with the man who broke the Bank of England. Writing in the Financial Times yesterday, Greenspan said: "The current financial crisis in the US is likely to be judged as the most wrenching since the end of the second world war."
The first 25 years after the war were relatively trouble free. Britain had devalued the pound in 1949 and 1967, but the first real systemic threat to the financial system arrived in 1973 with the secondary banking crisis that affected the "fringe banks" that had provided money to speculators during the property boom. When the crash came, the Bank of England launched a "lifeboat" to prevent the crisis spreading.
Similar action by the Federal Reserve in 1998 contained the fallout from the collapse of Long Term Capital Management, a hedge fund that lost money in the aftermath of Russia's decision to default on its debts. By comparison with recent events, LTCM now seems to be a minor market wobble.
Students of the markets say the only recent parallel with the current turmoil is Japan in the 1990s, but other than that they have had to study the 1930s, when 9,000 banks failed, 1907 when JP Morgan told Wall Street enough was enough after a 50% drop in shares, and even to the series of economic and financial upheavals during the final quarter of the 19th century.
Ben Bernanke, chairman of the Fed, spent years as an academic studying the Great Depression and his actions over the past six months have been interpreted as a sign that he is determined the lessons from the past should be understood.
Julian Jessop at Capital Economics said: "In our view the Fed is taking the right steps to prevent the recession from developing into a full blown depression that resembles the debt/deflation spiral that Japan found itself trapped in for more than a decade in the 1990s, or even the economic and financial disasters in the final quarter of the 19th century and the 1930s in the US."
Jessop added that all three episodes were characterised by the central bank's failure to prevent the money supply from contracting. "What we have seen from day one in this crisis is that the Fed recognises it needs to take whatever steps are necessary to prevent the money supply from falling and to inject as much liquidity as required to prevent a Japanese-style debt/deflation spiral from developing."
Japan's problems in the 1990s were caused by the pricking of a real estate and stock market bubble in the late 1980s that resulted in banks seeking to liquidate massive losses. The Japanese government was criticised for failing to take action quickly enough to prevent the economy suffering a series of recessions. Unlike today, however, the crisis had no global reach; the rest of the world boomed as Japan languished.
The stock market usually runs on 90 percent economics and 10 percent psychology. On Monday the proportions were reversed.
Fear rules, the future looks threatening and uncertain, and the biggest fear is the collapse of the U.S. financial system.
Because if a large veteran investment house such as Bear Stearns can go bankrupt after 85 years and with 14,000 employees, who can guarantee that this is the end of the crisis? What about Lehman Brothers? What about the banks themselves?
Fear has struck everyone. Investors said Monday that they did not want to be left with nothing, and therefore wanted to sell now. In the last hour and a half of trading Monday in Tel Aviv, mutual and provident fund managers were swamped with a wave of sell orders. They were left with no choice but to sell everything, anything they could get their hands on - even high-quality investments, since at least someone will be willing to buy the best goods, even in a falling market.
And that is how even the most solid companies, Bank Hapoalim and Bank Leumi fell sharply Monday, along with Africa Israel and The Israel Corporation. And Teva and Israel Chemicals. That is the definition of a crash - everything falls without any distinction between good and bad, including government bonds.
So is it a panic?
When we say panic, we mean an abnormal situation, one where you make mistakes when you are in a state of fear. Anyone who calls it a panic means that markets have fallen far enough, and now is the time to change direction.
But the stock market dropped in the last six months for a number of good reasons.
There are serious problems around the world that affect us too. The U.S. mortgage and hedge fund crisis is not over yet. The recession in America will hurt us here in Israel, since we are big exporters to the U.S.
Real estate prices are dropping, and oil and commodity prices are skyrocketing. Exporters to the U.S. are hurting from the weak dollar, and a credit crisis is now choking economic activity. The Israeli economy is no longer expected to grow by 5% this year, but only by 3.5%. So maybe this is not really a panic, but just an intelligent and accurate appraisal of reality.
Some people never wanted to face up to reality, and they built theories that there were two major economic centers in the world: the U.S. and China. The theory postulated that if the U.S. slows down, China will pick up the slack. But that is not what happened. Everything still depends on America. Those 300 million people still produce a third of the world's economy.
It seems that this is the way the world works: a crash every few years. We suffered one in 1977, another in 1983, then one in 1994 followed by another in 2000 - and now in 2008.
And there was always one real reason for the crashes: Greed.
From 2001 through July 2007, the American economy acted like it was crazy. They bought like crazy, and took on enormous debts - citizens as well as the government.
During those happy years, credit was cheap. Banks handed out expensive mortgages to poor borrowers. The entire American economy was like a giant pyramid scheme.
Huge demand led to two large bubbles: in real estate and stocks. Sooner or later they had to explode. And that is the difficult process we are witnessing now. Inflated prices are falling, risky investments are being wiped out, excess profits are disappearing, and the overly adventurous banks are being replaced.
That is why it is not a panic, but a hard and vicious process where all of us are paying the price. Because when the U.S. economy catches a cold, the entire world falls sick.
Last night, while America slept, investors and dollar-holders around the world held an impromptu election on US stewardship of the global economy. It was a spontaneous referendum triggered by the sudden collapse of Bear Stearns, but it covered many of the issues that have worried investors for the last seven years: the unfunded Bush tax cuts, the $2 trillion war in Iraq, the Federal Reserves low-interest bubble-making policies, the reckless gutting of US industrial base, the $4 trillion increase to the national debt, the multi-billion dollar "no bid" contracts, the opaque deregulated financial system, and the systematic destruction of the world's reserve currency. The ballots are still being counted, but the outcome is certain. The Bush administration lost in a landslide. Investors have had enough Bush's failed leadership and the Fed's reckless, globally-destabilizing monetary policies. A dollar-rout has already begun in earnest and stock markets around the world are plummeting. The Hang Seng index (Hong Kong) fell 4.3 percent to 21,279.40. Japan's benchmark Nikkei index slumped 3.7 percent to finish at 11,787.51, falling below 12,000 for the first time since August 2005. Shares throughout Europe tumbled overnight, shaving tens of billions off market capitalization. The Fed's panicky bailout of Bear Stearns and its surprise quarter-point rate cut has ignited a global equities sell-off and sent the cost of protecting corporate bonds through the roof. The economic tsunami is presently right outside New York ready to touch-down on Wall Street at the opening bell. The futures markets are already gyrating wildly. It should be a raucous St Patrick's day in the Big Apple.
Bernanke's 11th Hour Bailout of Bear Sparks Market Freefall
In the end, it was a race with the clock. The Federal Reserve wanted to get a deal done before the Asia markets opened hoping to soothe jittery investors and stop a full-blown stock market crash. It was right down to the wire, too. Less than an hour before trading began on Japan's Nikkei Index, the sale of beleaguered Investment giant, Bear Stearns was announced on Bloomberg News. Backed by a $30 billion line of credit from the Fed, JP Morgan reluctantly purchased Bear for the bargain-basement price of $240 million or $2 per share. Less than a year ago, Bear was riding high at $170 per share, but that was before the credit python had wrapped itself around US financial markets. That seems like ancient history now. Without the Fed's intervention the nearly-century old investment warhorse would have been dragged from Wall Street feet first. If the deal with JPM had flipped, Bear would have been forced into bankruptcy.
But Bear's travails are just the beginning of Wall Street's woes. Now there's talk of Lehman Brothers going under. According to the Wall Street Journal:
"Worries are deepening that other securities firms and commercial banks might be on shaky ground. Lehman Brothers Holdings Inc. Chief Executive Richard Fuld, concerned about the markets and possible fallout from Bear Stearns's troubles, cut short a trip to India and returned home Sunday, ahead of schedule, according to people familiar with the matter. The decision came after a series of calls Saturday to both senior executives at the firm and Treasury Secretary Henry Paulson, these people say." ("JP Morgan Rescues Bear Stearns", WSJ)Mr. Fuld has good reason to be concerned, too. Economics professor Nouriel Roubini says that, "Lehman's exposure to toxic ABS/MBS securities is as bad as that of Bear: according to Fitch at the beginning of the turmoil Bear Stearns had the highest toxic waste ("residual balance") exposure as percent of adjusted equity on balance sheet; the exposure of Bear was 54.5% while that of Lehman was only marginally smaller at 53.3%; that of Goldman Sachs was only 21%. And guess what? Today Lehman received a $2 billion unsecured credit line from 40 lenders. Here is another massively leveraged broker dealer that mismanaged its liquidity risk, had massive amount of toxic waste on its books and is now in trouble. Again here we have not only a situation of illiquidity but serious credit problems and losses given the reckless exposure of this second broker dealer to toxic investments." (Nouriel Roubini's Global EconoMonitor)
So, it looks like Bear will be just the first of many over-leveraged investment banks on their way to the chopping block. As credit gets tighter, banks will have to call in their loans to pare down their debts and increase their capital. That's easier said than done in an environment where consumer's are cutting back on borrowing and traditional revenue streams have dried up. The banks are facing some stiff headwinds in the near future.
The Federal Reserve announced two initiatives on Sunday designed to "bolster market liquidity and promote orderly market functioning."
The Fed is "creating a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York."
This is an incredible move and way beyond the Fed's mandate to insure price stability. Bernanke is now offering to accept dodgy mortgage-backed bonds from NON-BANK institutions. Outrageous. We can be 100% certain now, that Congress's closed door meeting on Friday had nothing to do with Bush's spyin