[R-G] Welcome to Year 27 of the Reagan Revolution

[Anthony Fenton]

http://counterpunch.org/November
      6, 2007

      "The End is
      Nigh!" Cries Paul Volcker, as Heads Topple at Merrill Lynch
      and Citigroup

      Welcome
      to Year 27 of the Reagan Revolution

      By MIKE WHITNEY

      Last Wednesday, the Federal Reserve
      dropped its benchmark interest rate by 25 basis points to 4.5
      per cent citing ongoing weakness in the housing sector. As expected,
      the stock market rallied and the Dow Jones Industrial Average
      went up137 points. Unfortunately, Bernanke's "low interest"
      stardust wasn't enough to buoy the markets through the rest of
      the week.

      On Thursday, the hammer fell.
      The Dow plunged 362 points in one afternoon on increasing fears
      of inflation, a slowdown in consumer spending, a steadily weakening
      dollar and persistent problems in the credit markets. By day's
      end, the Fed was forced to dump another $41 billion into the
      banking system to forestall a major breakdown. This is the most
      money the Fed has pumped into the financial system since 9/11/2001
      and it shows how dire the situation really is.

      Why do the banks need such
      a huge infusion of credit if they are as "rock solid"
      as Bernanke says?

      As most people now realize,
      the mortgage industry is on life-support. Many of the ways that
      the banks were generating profits have vanished overnight. The
      "securitization" of debt (mortgages, car loans, credit
      card debt etc) has ground to a halt. What had been a booming
      multi-billion dollar per-year business is now a dwindling part
      of the banks' revenues. Investors are steering clear of anything
      even remotely associated to real estate.

      Additionally, the banks are
      holding an estimated $200 billion in mortgage-backed securities
      and derivatives for which there is currently no market. This
      is compounded by $350 billion in "off balance sheets"
      operations -- which are collateralized with dodgy long-term mortgage-backed
      securities -- that provide funding for "short-term"
      asset-backed commercial paper. ASCP has shriveled by $275 billion
      in the last 10 weeks leaving the banks with gargantuan liabilities.
      Bernanke was forced to add $41 billion to keep the banking system
      from slipping beneath the waves. But that's just a short-term
      fix. In the long run, the Fed has less chance of stopping the
      market from correcting than it does of stopping a runaway truck
      by standing in its path. Besides, the Fed cannot purchase the
      banks' bad investments (CDOs, MBSs, or CP) nor can it reflate
      the multi-trillion dollar the housing bubble. All it can do is
      provide more cheap credit and hope the problems go away.

      So far, the lower rates haven't
      even decreased the price of the 30-year mortgage or made refinancing
      any cheaper. In truth, they're just a desperate attempt to perpetuate
      consumer borrowing while the banks figure out how to offload
      their enormous debts. That's what Paulson's $80 billion "Banker's
      Bankruptcy Fund" is really all about; it's just the repackaging
      of subprime junk so it can be passed off to credulous investors.
      Fortunately, the public has wised up and isn't buying into this
      latest fraud. As a result, the banks have taken another blow
      to their already-flagging credibility.

      In the last two months, the
      pool of qualified mortgage applicants has contracted, as has
      the market for merger and acquisition deals (private equity).
      So the banks are probably doing more with the Fed's $41 billion
      injection than just beefing up their reserves and issuing new
      loans. The market analysts at Minyanville.com summed it up like
      this:

      
        "Banks are taking the
        liquidity the Fed is forcing out there through the discount window
        and repos. After using it to shore up the declining value of
        their assets, they have excess to lend out. Finding no traditional
        borrowers that want to buy a house or build a factory, the new
        rules the Fed has set forth allows the banks to pass this liquidity
        onto their broker dealer subsidiaries in much greater quantities.
        These broker dealers are lending thus to hedge funds and margin
        buyers who are speculating in stocks. Remember, the Fed is powerless
        unless it can find people to borrow the credit it wants them
        to spend. By definition, the last ones willing to take that credit
        are the most speculative."

      This is a likely scenario given
      the fact that the stock market continues to fly high despite
      the surge of bad news on everything from the falling dollar to
      the geopolitical rumblings in the Middle East. Last month, the
      Fed modified its rules so that the banks could provide resources
      to their off-balance sheets operations (SIVs and conduits). If
      the Fed is willing to rubber-stamp that type of monkey-business;
      then why would they mind if the money was stealthily "back-doored"
      into the stock market via the hedge funds?

      This might explain why the
      hedge funds account for as much as 40 to 50 per cent of all trading
      on an average day. It also explains why the stock market is overheating.

      The charade cannot go on forever.
      And it won't. Rate cuts do not address the underlying problem
      which is bad investments. The debts must be accounted for and
      written off. Nothing else will do. That doesn't mean that Bernanke
      will suddenly decide to stop savaging the dollar or flushing
      hundreds of billions of dollars down the investment bank toilet.
      He probably will. But, eventually, the blow-ups in the housing
      market will destabilize the financial system and send the banks
      and over-leveraged hedge funds sprawling. Bernanke's low interest
      "giveaway" will amount to nothing.

      Bloomberg News ran a story
      last week which sheds more light on the jam the banks now find
      themselves in:

      "Banks shut out of the
      market for short-term loans are finding salvation in a government
      lending program set up to revive housing during the Great Depression.
      Countrywide Financial Corp., Washington Mutual Inc., Hudson City
      Bancorp Inc. and hundreds of other lenders borrowed a record
      $163 billion from the 12 Federal Home Loan Banks in August and
      September as interest rates on asset-backed commercial paper
      rose as high as 5.6 percent. The government-sponsored companies
      were able to make loans at about 4.9 percent, saving the private
      banks about $1 billion in annual interest."

      Whoa. So, now that the credit
      markets have frozen over, the banks are going to the government
      with begging bowl in hand? So much for "moral hazard".

      Commercial paper is short-term
      notes that businesses use for daily operations. Because much
      of this CP is backed by mortgage-backed securities the banks
      have been having trouble rolling it over. (Refinancing) So --
      unbeknownst to the public -- various banks have been borrowing
      from the government-sponsored Federal Home Loan Banks (FHLB)
      so they can cut their losses (or stay afloat?) The FHLB has extended
      $163 billion of loans to them, which means that the risks that
      are inherent in supporting "dodgy banks that make bad bets"
      has been transferred to FHLB's investors. The danger, of course,
      is that-when investors find out that FHLB is mixed up with these
      shaky banks, they are liable to sell their shares and trigger
      a collapse of the system.

      Citi's Woes

      Over the weekend, Citigroup's
      CEO Chuck Prince got the axe. Citigroup, which boasts more than
      300,000 staff worldwide, has lost more than 20 per cent of its
      market value from bad bets in sub-prime mortgages. According
      to the Times Online: "The Securities and Exchange Commission
      may investigate whether it improperly juggled its books to hide
      the full extent of the problem."

      "Juggled" is not
      a word that is taken lightly on Wall Street where traders are
      now bracing for another sell-off of financial stocks. Mr. Prince
      is not alone in the unemployment line either. He's be accompanied
      by Merrill Lynch's former boss, Stanley O' Neal who got the boot
      last week when his firm reported $8.4 billion in write-downs.
      Deutsche Bank analysts now predict that Merrill may write off
      another $10 billion of losses related to its portfolio of sub-prime
      debts. That would wipe out 8 full quarters of earnings and represent
      the largest loss in Wall Street history.

      The news is bleak. The systemic
      rot is appearing everywhere presaging ongoing losses for the
      financial giants and a long-downward spiral for the markets.
      The banks are currently under-regulated, over-leveraged and under
      capitalized.

      Former Fed chief Paul Volcker
      summarized the overall economic situation last week at the second
      annual summit of the Stanford Institute for Economic Policy Research.
      In his speech he said:

      
        "Altogether, the circumstances
        seem as dangerous and intractable as I can remember.Boomers are
        spending like there is no tomorrow. Homeownership has become
        a vehicle for borrowing and leveraging as much as a source of
        financial security.. As a Nation we are consumingabout 6 per
        cent more than we are producing. What holds it all together?
        - High consumption - high leverage - government deficits - What
        holds it all together is a really massive and growing flow of
        capital from abroad. A flow of capital that today runs to more
        than $2 billion per day." The nation is facing "huge
        imbalances and risks."

      Volcker is right. The country
      is in a bigger pickle than any time in its 230 year history.
      The credit storm that was engineered at the Federal Reserve has
      swept across the planet and is now descending on commercial real
      estate, credit card debt, and the plummeting bond insurers industry.
      These are the next shoes to drop and the tremors will be felt
      throughout the broader economy.

      As this article is being written,
      Reuters is reporting that Citigroup may be forced to write-down
      as much as $11 billion in subprime mortgage-related losses!

      Reuters: "Citigroup announced
      today significant declines since September 30, 2007 in the fair
      value of the approximately $55 billion in U.S. sub-prime related
      direct exposures in its Securities and Banking (S&B) business.
      Citi estimates that, at the present time, the reduction in revenues
      attributable to these declines ranges from approximately $8 billion
      to $11 billion (representing a decline of approximately $5 billion
      to $7 billion in net income on an after-tax basis)."

      Citigroup's statement indicates
      a willingness on its part to come clean with its investors but,
      in fact, they know that the situation is fluid and there'll be
      hefty losses in the future. Mortgage-backed securities (MBSs)
      and collateralized debt obligations (CDOs) will continue to be
      downgraded as time goes by. According to the Financial Times,
      one banker was having so much difficulty getting a bid on subprime
      securities; he found the only way he could get rid of them was
      through "barter. He resorted to using a tactic more normally
      associated with third world markets than the supposedly sophisticated
      arena of high finance. 'Barter is the only thing that works,'
      he chuckled, 'It's like the Dark Ages'" The article continues:

      
        "Never mind the fact that
        the risky tranches of subprime-linked debt have fallen 80 per
        cent since the start of the year; in a sense, such declines are
        only natural for risky assets in a credit storm. Instead, what
        is really alarming is that the assets which were supposed to
        be ultra-safe - namely AAA and AA rated tranches of debt - have
        collapsed in value by 20 per cent and 50 per cent odd respectively.
        This is dangerous, given that financial institutions of all stripes
        have been merrily leveraging up AAA and AA paper in recent years,
        precisely because it was supposed to be ultra-safe and thus,
        er, never lose value." (Financial Times; Gillian Tett)

      AAA and AA assets---the top-graded
      tranches--- have already been downgraded by 20 per cent to 50
      per cent! And the prices are bound to fall even more because
      there is no market for mortgage-backed securities. This is a
      bank's worst nightmare; an asset that loses value and requires
      greater capital reserves every day. In fact, AAA rated MBSs have
      dropped 14 per cent in one month. It is truly, death by a thousand
      cuts.

      The US financial system is
      now buckling beneath the weight of its own excesses. The subprime
      contagion---which can trace its origins to the expansion of credit
      at the Federal Reserve -- has devastated the housing market generating
      an unprecedented number of foreclosures, record inventory, and
      a multi-trillion dollar equity bubble which is now deflating
      and wiping out much of the mortgage industry in its path. Its
      effects on the secondary market have been even more devastating
      where pension funds, insurance companies, hedge funds and foreign
      banks are left holding hundreds of billions of dollars of complex,
      mortgage-backed securities and subprime-related derivatives which
      are now destined to be downgraded to pennies on the dollar ravaging
      once-robust portfolios. The subprime meltdown has been equally
      damaging to myriad European investment banks and brokerage houses.
      We've seen a wave of bank closings in France, Germany and England
      which has left investors shell-shocked, triggering capital flight
      from American markets and supplanting confidence in the US financial
      system with growing suspicion and rage. Where are the regulators?

      According to Bloomberg News,
      "European and Asian investors will avoid most US mortgage-backed
      securities for years without guarantees from government-linked
      entities creating an enormous drag on the US housing market".
      Foreign investors believe they were hoodwinked by bonds that
      were deliberately mis-rated to maximize profits for the investment
      banks. This may explain why $882 billion has been diverted into
      Chinese and Indian stock markets in the last month alone.

      The biggest losers of all,
      however, are the financial giants that created most of the abstruse,
      debt-instruments that are now devouring the system from within.
      The productive and "wealth creating" components of
      the economy have been subordinated to a finance-driven model
      which suddenly derailed due to the abusive expansion of debt.
      Inevitably, some of the banks that took the greatest risks will
      be shuttered and trillions of dollars in market capitalization
      will disappear.

      Is it possible that anyone
      with a pulse and a minimal ability to reason couldn't see the
      inherent problems of building a financial edifice on the prospect
      that millions of first-time homeowners with bad credit history
      and no collateral would pay off there mortgages in a timely and
      responsible manner?

      No. It is not possible. The
      real reason that the subprime swindle mushroomed into an economy-busting
      monster is that the markets are no longer policed by any agency
      that believes in intervention. The pervasive "free market"
      ideology rejects the notion of supervision or oversight, and
      as a result, the markets have become increasingly opaque and
      unresponsive to rules that may assure their continued credibility
      or even their ability to function properly.

      The "supply side"
      avatars of deregulation have transformed the world's most vital
      and prosperous markets into a huckster's shell-game. All regulatory
      accountability has vanished along with trillions of dollars in
      foreign investment. What's left is a flea-market for dodgy loans,
      dubious over-leveraged equities and "securitized" Triple
      A-rated garbage.

      Let's hear it for the Reagan
      Revolution.

      What is striking is how the
      new "structured finance" paradigm replicates a political
      system which is no longer guided by principle or integrity. It
      is not coincidental that the same flag that flies over Guantanamo
      and Abu Ghraib flutters over Wall Street as well. Nor is it accidental
      that the same system that peddles bogus, subprime tripe to gullible
      investors also elevates a "waterboarding advocate"
      to the highest position in the Justice Department. Both phenomena
      emerge from the same fetid swamp.

      Mike Whitney lives in Washington state. He can
      be reached at: fergiewhitney at msn.com