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By Mike Whitney
24/07/08 "ICH" -- - Last Wednesday, at an improvised press conference, George Bush gave what may have been the most comical performance of his eight year presidency. Looking like the skipper on the flight-deck of the Hindenburg, Bush tried his best to reassure the public that "all's well" with the economy and that everyone's deposits were perfectly safe in the rapidly disintegrating US banking system. Leaning lazily on the presidential podium, Bush shrugged his shoulders and said,
“My hope is that people take a deep breath and realize that their deposits are protected by our government. We're not seeing the growth we’d like to see, but the financial system is basically sound."
Right. "Breath deep" and chill out; no need to panic. One shouldn't let the long lines of anxious depositors who are presently trying to extract what's left of their life savings from the now-defunct Indymac Bank upset one's basic equanimity. The banking system is perfectly safe, you heard it from President Trickledown himself.
At the same time Bush was offering his soothing words on all the major TV news networks, Fed chairman Ben Bernanke was on the other side of Washington giving a decidedly grimmer assessment of the economy:
"The contraction in housing activity that began in 2006 and the associated deterioration in mortgage markets that became evident last year have led to sizable losses at financial institutions and a sharp tightening in overall credit conditions. The effects of the housing contraction and of the financial headwinds on spending and economic activity have been compounded by rapid increases in the prices of energy and other commodities, which have sapped household purchasing power even as they have boosted inflation. Against this backdrop, economic activity has advanced at a sluggish pace during the first half of this year, while inflation has remained elevated."
Keep in mind, that these two events were perfectly coordinated to take place at exactly the same time; 10:20 AM Wednesday. Quite a coincidence, eh? Just another masterful public relations coup engineered by the Bush PR team, the last functioning agency in the entire bureaucracy. To no one's surprise, the collusive media managed to divert attention from the impending financial firestorm long enough to lull the American people into believing that nothing is really wrong; the economy is just hunky-dory.
Fed-chief Bernanke again:
"The economy continues to face numerous difficulties, including ongoing strains in financial markets, declining house prices, a softening labor market, and rising prices of oil, food, and some other commodities....The deteriorating performance of subprime mortgages in the United States triggered turbulence in domestic and international financial markets as investors became markedly less willing to bear credit risks of any type....Many financial markets and institutions remain under considerable stress, in part because the outlook for the economy, and thus for credit quality, remains uncertain."
As Bernanke delivered one hammer-blow after another, our engaging Commander in Chief was busy swapping funny stories and rough-housing with his pals in the Washington press corps. The media confab turned out to be a typical Bush frat-party with plenty of back-slapping and hee-haws to go around.
"You had a question, Stretch?" (Ha, ha)
And that was that. Bernanke's candid and (frankly) scary assessment of the economy was dwarfed by Bush's diversionary palavering and bravado; another stunning victory for the White House spinmeisters. Even so, the Fed chairman's testimony should be dug up and examined by anyone who is interested in knowing how bad things really are so they can prepare themselves for the hard times ahead. (Find it here: Bernanke's Semiannual Monetary Policy Report to Congress; http://www.federalreserve.gov/newsevents/testimony/bernanke20080715a.htm )
"In the housing sector, activity continues to weaken...Home prices are falling, particularly in regions that experienced the largest price increases earlier this decade. The declines in home prices have contributed to the rising tide of foreclosures; by adding to the stock of vacant homes for sale, these foreclosures have, in turn, intensified the downward pressure on home prices in some areas....The declines in home prices have contributed to the rising tide of foreclosures; by adding to the stock of vacant homes for sale, these foreclosures have, in turn, intensified the downward pressure on home prices in some areas......Surveys of capital spending plans indicate that firms remain concerned about the economic and financial environment, including sharply rising costs of inputs and indications of tightening credit, and they are likely to be cautious with spending in the second half of the year."
The economic sky is quickly darkening and Bernanke made no effort to hide his concern. His testimony was as close to the truth as one gets in Washington where honesty is usually eradicated like a malignant tumor. In any event, it is worth wading through Bernanke's speech word by word even if it only reinforces one's belief that the economy is about to take a sleigh-ride through a deflationary blast-furnace which will ultimately result in the demise of Breton Woods, the disorderly replacement of the dollar as the world's reserve currency, and an end to the United States short-lived dominance as the world's lone superpower. The American Century has about run out of steam just eight years into the new mellenium. Bernanke's presentation confirms what the econo-bloggers have been saying for the past three years; the end is nigh, get your house in order.
Personal consumption is down, the labor market is softening, and food and fuel prices are soaring. Housing values are plummeting, wages have stagnated, and American households are more overextended, underpaid and stressed out than anytime in history. It's all bad. No wonder consumer confidence is at its nadir.
"THE SUMMER OF 1931"?
The next shoe to drop is the stock market. Its not that complicated either; when wholesale prices on supplies and raw materials go up, but businesses can't pass along those costs because consumers are already maxed-out, then corporate profits plummet and the stock market crashes down with the force of an avalanche.
Journalist Ambrose Evans-Pritchard summed it up like this:
"It feels like the summer of 1931. The world's two biggest financial institutions have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution. The International Monetary Fund has abdicated into schizophrenia....My view is that a dollar crash will be averted as it becomes clearer that contagion has spread worldwide. But we are now at the point of maximum danger." (Ambrose Evans- Pritchard, "The Global Economy is at the point of maximum danger", UK Telegraph
"Maximum danger", indeed. Stock market mayhem is just around the corner. Visualize the Dow at 6,000 and then hang on for dear life. The indexes will tumble and Wall Street will be reduced to Dresden-type rubble, nothing left but toxic fumes and twisted iron. By the end of 2009, the last few bulls will be driven out of the exchanges and onto the streets where they'll be slaughtered one by one. It won't be pretty.
According to Bloomberg News: "Investors worldwide are betting more than $1 trillion on a collapse in stock prices".
But no matter how bad it gets, the media will still bang-out its "Sunny Jim" market-forecasts while reiterating every mangled phrase and muddled thought from our alcohol-addled Dear Leader. The lines from the shelters, pawn shops and soup kitchens may stretch from the Golden Gate to the Statue of Liberty, but the perennially upbeat predictions of a "bottom in housing" or an "economic turnaround" will continue to blast from every media bullhorn in the nation. America's financial media is an never-ending source of baseless optimism and hogwash.
It's funny; while Bush was hosting his faux-press conference, live-footage was appearing on other media of fully-armed LA policemen being dispatched to the various Indymac locations. Their task was to remind the gathering of elderly "blue-hair" women and middle-aged white guys in Tommy Bahama T-shirts that any public display of outrage would be swiftly met with Rodney King-style justice. Hmmm. So now withdrawing one's savings from the bank is not only riskier; it's tantamount to committing a felony. My, how America has changed.
Just imagine the frustration of spending $5 a gallon for gas to drive to the local Indymac branch to get whatever is left of your savings only to get roughed-up by the local constabulary. Nice touch, eh?
Going to the bank? Don't forget the protective head-gear!
The truth is the banking system is built on a foundation of pure quicksand and its only a matter of time before the Bush's truncheon-wielding Robocops start tasering old ladies and gassing portly white guys for massing in front of the boarded up doors of their local bank. Move along, now.
Market Ticker's Denniger made this insightful observation about about the present condition of the banking system. He said, "Why does Paulson keep telling us that the banking system is sound every time he gets within 200' of a microphone?
Maybe it is because the banking system is on the verge of all-out collapse, and he knows you could blow it over with a feather!" (The Market-Ticker)
It is worth noting that the demise of Indymac is expected to cost the FDIC around $8 billion of its meager $53 billion of reserves. 4 or 5 bank failures of equal size and the FDIC will be underwater, which is a serious problem since even conservative estimates expect bank failures to run into the hundreds. The Fed will be forced to monetize the debt, further weakening the dollar.
But Indymac is small potatoes compared to the liabilities of the two mortgage behemoths, Fannie Mae and Freddie Mac. Years of sketchy accounting, risky investments, abusive lending, and political cronyism have eroded the two Government Sponsored Enterprises (GSEs) balance sheets and pushed them to the brink of insolvency. If they fail, it will be disastrous for the US taxpayer who will be expected to guarantee $5.2 trillion of US residential mortgages, hundreds of billions of which was lent to borrowers who will likely default on their loans in the next few years. As the housing bubble continues to fizzle; Fannie and Freddie will face losses of $500 billion or more, forcing disgruntled foreign investors to ditch their bonds and make for the exits. When that happens, long-term interest rates will skyrocket and the ailing dollar will collapse in a heap. The Bush administration can't allow that to happen, which means that Henry Paulson will push for emergency funding from the congress (which he is doing now) so he can rebuild investor confidence and stop the hemorrhaging of foreign capital. Whether Fannie and Freddie are saved or not, it is bound to be a drain on the dollar which can only get weaker as deficits soar and confidence wanes. There's really very little chance the dollar will survive as the "international currency".
Economist Nouriel Roubini summed it up like this:
"The existence of GSEs...is a major part of the overall U.S. subsidization of housing capital that will eventually lead to the bankruptcy of the U.S. economy. For the last 70 years investment in housing –- the most unproductive form of accumulation of capital -– has been heavily subsidized in 100 different ways in the U.S.: tax benefits, tax-deductibility of interest on mortgages, use of the FHA, massive role of Fannie and Freddie, role of the Federal Home Loan Bank system, and a host of other legislative and regulatory measures.
The reality is that the U.S. has invested too much – especially in the last eight years – in building its stock of wasteful housing capital (whose effect on the productivity of labor is zero) and has not invested enough in the accumulation of productive physical capital (equipment, machinery, etc.) that leads to an increase in the productivity of labor and increases long run economic growth. This financial crisis is a crisis of accumulation of too much debt ---by the household sector, the government and the country –- to finance the accumulation of the most useless and unproductive form of capital, housing, that provides only housing services to consumers and has zippo effect on the productivity of labor." (Seeking Alpha, "Just How Terrible is Housing as an Asset Class? Roubini Weighs In")
Fannie and Freddie made a big mistake by shifting into mortgage-backed securities (MBS) in the 1990s. From 1997 to 2007, Fannie’s portfolio of dodgy MBS jumped from $18.5 billion to $127.8 billion by the end of 2007. The numbers at Freddie were even higher. Now they're caught in the same downgrading-spiral as the investment banks, with billions of dollars of assets steadily losing value every month. It's death by a thousand cuts. The losses have left the two GSEs cash-starved and searching frantically for new sources of capital to build their cushion. Regrettably, foreign sovereign wealth funds feel like they were burned in the Citigroup bailout and are no longer in the market for destitute US investment banks.
Here's "The Economist" shedding a little more light of Fannie and Freddie's creative bookkeeping:
"The companies have also been unwilling to accept the pain of market prices in acknowledging delinquent loans. When borrowers fail to keep up payments on mortgages in the pool that supports asset-backed loans, Fannie and Freddie must buy back the loan. But that requires an immediate write-off at a time when the market prices of asset-backed loans are depressed. Instead, the twins sometimes pay the interest into the pool to keep the loans afloat. In Mr Rosner’s view, this merely pushes the losses into the future." (The Economist, "The End of Illusions")
Nice, eh? Wouldn't it be great if guys didn't have to explain to their wives why they pissed away their paycheck at the race track? Apparently, it's okay for Fannie and Freddie; just keep paying the interest on bad loans and no one's the wiser. What a racket. This is the type of sleazy Enron-type accounting that goes unchallenged in Washington where everyone fudges the numbers to hide their losses from their shareholders or taxpayers, as the case may be. That's why the namby-pamby regulators at the SEC need to be replaced with a few knuckle-dragging Abu Ghraib interrogators. There's nothing going on at Fannie and Freddie that a set of leg-irons and a few lively dunks on a waterboard wouldn't fix.
THE ROAD TO PERDITION: Paulson's Scatterbrain Capitalism
Something has gone terribly wrong with the economy, but no one wants to say what it is. This is more than just a typical downturn in the demand-cycle or a temporary "rough patch". In fact, it's not a recession at all; it is a meltdown of the financial system. And it's obvious. The "deep pocketed" Federal Reserve is currently providing hundreds of billions of dollars through its auction facilities to the most craven speculators on the planet, the investment banks. These very same banks have no ability to pay that money back. Show me their revenues; show me their assets; show me their capital cushion which is calculated mainly in terms of "Level 3 assets" and which allow the banks to assign their own value to the bad paper that's overflowing from their vaults. Have you ever heard of anything more ridiculous? One blogger called Level 3 assets "mark to fantasy". He's right, too. It's all smoke and mirrors. So why are we letting crooks decide what their assets are worth?
True, a few of the investment banks just reported "better than expected" earnings, but no one on Wall Street is fooled by that baloney. The SEC changed the rules on shorting bank stocks just days before their earnings reports were due; another gift from Uncle Sam to hide the dirty laundry. Also, some of the banks have started extending their "write downs" from 120 days to 160 days, buying themselves a little more time to deceive their shareholders about the size of their losses. It's all one big swindle following another. The whole business stinks to high heaven and the Bush administration is right there in bed with them, snuggling up close and holding their hands.
If the public grasped the significance of the Bear Stearns fiasco, they'd understand how grave the situation really is. The technical details are irrelevant; don't bother with them. What IS important is that the Fed acknowledged that the investment speculators had so polluted the financial system with their toxic, unregulated garbage,(Credit default swaps) that if the transaction with JP Morgan flopped, the entire system would have imploded. Think about that. In other words, the legitimate, "Real Economy" is now inextricably lashed to a massive $500 trillion dollar unregulated shadow banking system that operates without rules, supervision or sufficient capital. Over the counter derivatives trading is a cancer that has spread to every part of the system and is devouring it from the inside. It's only a matter of time before the patient succumbs. That's what the Bear bailout really means; the rest is bunkum.
The banking system is broke, busted, penniless; and yet the Fed and the G-7 allow this comedy to persist like nothing is wrong. When will the American people wake up?
And, will someone please explain how free markets can exist when speculators are subsidized by the state, or when the risk is removed from risky investing? That's what it means when the Fed opens its auction facilities to the investment banks and brokerage houses. It makes no sense at all. Government "safety nets" are anathema to free market capitalism. "You pays yer money and you takes yer chances". That's finance capitalism; deal with it.
What we are seeing is a hybridized version of capitalism; "Paulson's Scatterbrain Capitalism"; a hodge-podge of taxpayer bailouts, government intervention and free market mumbo jumbo. It's a toxic mix on off-balance sheets operations, over-the-counter "unregulated" derivatives, dark pool trading, opaque hedge funds, dodgy Enron-style accounting, and complex, hard-to-pronounce debt-instruments wrapped up into one, cheesy, unsustainable shell game, managed by Harvard-educated flim flam men and backed by a 100% government guarantee. That's the system we're supporting with our tax dollars and that's the system that is dragging us headlong to ruin.
It ain't capitalism, my friend. It's a crooked system run by corporate carpetbaggers and banking scalawags who shot the Golden Goose in hopes of keeping the larder at the cottage on the New Jersey coast chock-full of Dom Perignon and halibut fillets. They created this nightmare and they've doomed us all.
As long as we prop up the existing system, the economy will flounder, unemployment will rise, foreclosures will soar, banks will be shuddered, and the wobbly old greenback will continue its inexorable march towards Pesoville. It's time to clean house and we can start by firing Paulson.
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