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America's Teetering Banking System:
"Where did all our deposits
go?"
By
Mike Whitney
31/01/08 "ICH"
-- -
Somebody goofed. When Fed chairman Ben Bernanke cut interest
rates to 3% yesterday, 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%. The same thing happened to the 10 year
Treasury which surged from a low of 3.28% to 3.73% in less than
a week. That means that mortgageswhich 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.
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 8 days ago, when he cut
rates by 75 basis points, the ten-year didn't budge from its
perch at 3.64%. It just shrugged it off the cuts as meaningless.
But a couple days later, when Congress passed Bush's $150
"Stimulus Giveaway", the ten 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
look at these graphs and you'll see what Bernanke saw before he
decided to cut interest rates.
http://benbittrolff.blogspot.com/2008/01/really-scary-fed-charts-why-bernanke.html
NEGATIVE BANK RESERVES;
The banks are busted.
In 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 from 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;
http://globaleconomicanalysis.blogspot.com/) 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 similar structured investments.
HOW
CAPITAL IS DESTROYED
When
US homeowners default on their mortgages en-mass, 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�MBSs, CDOs, and Commercial
Paper---has evaporated leaving the banks with astronomical
losses. They are incapable of rolling over their 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 down-graded 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% interest rates, Bernanke will be stymied by
the unwillingness of under-capitalized banks to lend or
over-extended 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---ten 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,
yesterday, but by early 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.
The
plight of other major bond insurers, MBIA and Ambac, could be
known as early as today, but it is reasonable to expect that
they will lose their Triple A rating. According to Bloomberg:
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.
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 yesterday 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 gold-mine 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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