The most Radical Financial Intervention in History:
Every Trick in the Book
by Mike Whitney / December 2nd, 2008
Conditions have deteriorated on a scale and with a speed that no one could
have predicted just a few months ago. Market conditions of unprecedented
strength are roiling the world's financial markets. The global economy is
either in, or close to, recession and 2009 is not likely to be a year of
great recovery.
- Brett White, chief executive officer of CB Richard Ellis, LA Times
Without any public debate or authorization from Congress, the Federal
Reserve has embarked on the most expensive and radical financial
intervention in history. Fed chairman Ben Bernanke is trying to avert
another Great Depression by flooding the financial system with liquidity in
an attempt to mitigate the effects of tightening credit and a sharp decline
in consumer spending. So far, the Fed has committed over $7 trillion, which
is being used to backstop every part of the financial system including money
markets, bank deposits, commercial paper (CP) investment banks, insurance
companies, and hundreds of billions of structured debt-instruments (MBS,
CDOs). America's free market system is now entirely dependent on state
resources.
With interest rates at or below 1 percent, Bernanke is "zero bound", which
means that he will be unable to stimulate the economy through traditional
monetary policy. That leaves the Fed with few choices to slow the
debt-deflation that has already carved $7 trillion from US stock indexes and
another $6 trillion from home equity. Bernanke will have to use
unconventional means to stabilize the system and maintain economic activity
in the broader economy.
Last Tuesday, Treasury Secretary Henry Paulson announced that the Fed would
buy $600 billion of toxic mortgage-backed securities (MBS) from Fannie Mae
and Freddie Mac, in effect, buying up its own debt. This is one of the
unconventional strategies that Bernanke outlined in a speech he gave in 2002
on how to avoid deflation. By moving the MBS from Fannie's balance sheet to
the Fed's, Bernanke was able down interest rates by a full percentage point
overnight, creating a powerful incentive for anyone thinking about buying a
home. But Bernanke's plan is not risk free; it increases the Fed's long-term
liabilities, which in turn undermines the dollar. This calls into question
the creditworthiness of the US Treasury, which is becoming more and more
uncertain every day.
The Fed also initiated a program to purchase $200 billion of triple A-rated
loans from non-bank financial institutions to try to revive the flagging
securitization market. It's another risky move that ignores the fact that
investors are shunning "pools of loans" because no one really knows what
they are worth. The appropriate way to establish a price for complex
securities in a frozen market is to create a central clearinghouse where
they can be auctioned off to the highest bidder. That establishes a baseline
price, which is crucial for stimulating future sales. But the Fed wants to
conceal the true value of these securities because there are nearly $3
trillion of them held by banks and other financial institutions. If they
were priced at their current market value ($.21 on the dollar) then many of
the country's biggest banks would have to declare bankruptcy. So the Fed is
trying to maintain the illusion of solvency by overpaying for these
securities and providing the financing companies more capital to loan to
businesses and consumers. Once again, the Fed is stretching its balance
sheet by trying to resuscitate a structured finance system that has already
proved to be dysfunctional.
Bernanke would be better off letting the market decide what these
debt-instruments are really worth. There are always buyers if the price is
right. Just look at what happened in Southern California last month, where
there was a shocking turnaround in the housing market. Home sales in Orange
Country shot up 55 percent year over year in October. That's because prices
have dropped 36 percent from their peak in 2007. This proves that real
estate - like complex securities - will recover when investors feel that
prices are fair.
Does Bernanke really believe that his maneuvering will change the direction
of the market or convince investors to pay full-price for dodgy securities?
Who knows, but we do know that the Fed has no mandate to prop up asset
values, which the market has already decided are worth considerably less. It's
the equivalent of price fixing.
Bernanke's Bag O' Tricks
In the coming weeks, the Fed chairman will probably employ many of the
radical policy options he laid out in his 2002 speech. Economist Nouriel
Roubini points out that nearly all of these choices "imply serious risks for
the Fed" as well as the American people. Roubini says:
"Such risks include the losses that the Fed could incur in purchasing long
term private securities, especially high yield junk bonds of distressed
corporations . . . . Pushing the insolvent Fannie and Freddie to take even
more credit risk may be a reckless policy choice. And having a government
trying to manipulate stock prices would create another whole can of worms of
conflicts and distortions.
Finally, the Fed could try to follow.massive quantitative easing; flooding
markets with unlimited unsterilized liquidity; talking down the value of the
dollar; direct and massive intervention in the forex to weaken the dollar;
vast increase of the swap lines with foreign central banks. aimed to prevent
a strengthening of the dollar; attempts to target the price level or the
inflation rate via aggressive preemptive monetization; or even a
money-financed budget deficit." (Nouriel Roubini's EconoMonitor)
Last Tuesday's announcement suggests that Bernanke may be dabbling in the
stock market already. This forces anyone who is planning to short the market
to reconsider his strategy because Bernanke could be secretly betting
against him by dumping billions in the futures market to keep stocks
artificially high. It just goes to show that all the bloviating about the
virtues of "free market" is just empty rhetoric. When push comes to shove
this is "their" system and they'll do whatever they can to preserve it. If
that means direct intervention, so be it. Principles mean nothing.
Bernanke's actions are likely to wreak havoc in the currency markets, too.
If currency traders suspect that Bernanke is printing money ("unsterilized
liquidity") to rev up the economy, there will be a sell-off of US Treasuries
and a run on the dollar. "Monetization" - the printing money to cover one's
debts - is the fast-track to hyperinflation and the destruction of the
currency. It's not a decision that should be taken lightly. And it is not a
decision that should be made by a banking oligarch who has not been given
congressional approval. Bernanke's shenanigans show an appalling contempt
for the democratic process. He needs to be reigned in before he does more
damage.
Bernanke's attempts to revive the securitization market is understandable,
but it probably won't amount to anything. The well has already been poisoned
by the lack of regulation and the proliferation of subprime loans. The
problem is that the broader economy needs the credit that securitization
produced via the non bank financials (investment banks, hedge funds etc) In
fact, the non bank financial institutions were providing the lion's share of
the credit to the financial system before the meltdown. But, now that the
five big investment banks are either bankrupt or transforming themselves
into holding companies (and the hedge funds are still deleveraging) the only
option for credit is the banks, and they are incapable of filling the void.
The Wall Street Journal estimates that the loss of Bear Stearns and Lehman
Bros. will mean "$450 billion in lending capacity missing from markets".
Think about that. If we include the other investment banks in
the mix, then more than $2 trillion in credit will vanish from the system
next year alone. Bottom line, the breakdown in securitization is choking off
credit and pushing the country towards catastrophe. If the slide continues,
there could be a 40 percent reduction in credit in 2009 making another great
Depression unavoidable.
Does that mean we should revive the failed system?
No, just the opposite. The markets need to be re-regulated now to restore
credibility. But the Fed should looking for ways to create an emergency
National Bank, which operates like a public utility, so that credit can be
made available to businesses and consumers who need it now. The Treasury
should also be working with Congress on a plan for public education to
forestall a panic as well as recommendations for stimulus to soften the
economic hard landing just ahead.
The financial system is broken and institutions will not be able to
releverage fast enough to normalize the credit markets or stop the impending
collapse in consumer demand. What's needed is a constructive plan to rebuild
the system while minimizing the suffering of normal people. There's no sense
in trying to put the genie back in the bottle or re-energize a failed
system. What's past is prologue. There needs to be a serious analysis of the
factors that led to the present crack-up and a plan for course-correction.
It's not enough to throw stones at the Fed and its misguided serial
bubble-making escapades.
Reagan's Legacy
Our present dilemma can be traced back to the 1980s - the Reagan era - and
the rise of an organized, industry-funded movement, which advanced their
business-friendly, "trickle down" ideology which, when put into practice,
has led to greater and greater income disparity, unprecedented expansion of
credit and, ultimately, economic disaster.
The problem is the way that the system has been reworked to serve the
interests of the investor class at the expense of working people. As Wall
Street has tightened its grip on the political parties, more of the nation's
wealth has gone to a smaller percentage of the population while the chasm
between rich and poor has grown wider and wider. The United States now has
the worst income and wealth disparity since 1929 and a whopping 75 percent
of the labor force has seen a drop in their living standard since 1973. The
average American has no savings and a pile of bills he is less and less able
to pay. Apart from the ethical questions this raises, there is the purely
practical matter of how a consumer-driven economy (GDP is 70% consumer
spending in US) can maintain long-term growth when wages do not keep pace
with productivity. It's simply impossible. The only way the economy can grow
is if wages are augmented with personal debt; and that is exactly what
has happened. The fake prosperity of the Bush and Clinton years can all be
attributed to the unprecedented and destabilizing expansion of personal
debt. Wages have been stagnate throughout.
The architects of the present system knew what they were doing when they
cooked up their supply side theory. They were creating the rationale for
shifting wealth from one class to another. But the theory is deeply flawed
as the current crisis proves. Economic conditions do not improve when the
rich get richer. All boats do not rise. Class divisions intensify and
imbalances grow. Equity bubbles may be an effective means of social
engineering, but they always lead to disaster. In fact, the crash of the Fed's
massive debt bubble could bring down the whole system in heap. There are
better ways to allocate resources so that everyone benefits equally.
It all gets down to wages, wages, wages. If wages don't grow, neither will
the economy. Author Ravi Batra sums it up like this in his book Greenspan's
Fraud:
"A bubble economy is born when wages trail productivity for some time and
result in ever-rising debt. Then profits grow faster than productivity
gains, and share prices outpace GDP growth. However, a time comes when
debt-growth slows down, and demand falls short of output, resulting in
profit decline and a stock market crash. Thus, the very force that generates
the stock market bubble seeds its crash." (Greenspan's Fraud: Ravi Batra,
Palgrave Macmillan, p 152)
The "trickle down" Voodoo economic model was destined to fail because it was
built on a fiction. Prosperity is not possible when workers are not fairly
compensated and wealth is not equitably distributed. Our focus should be on
creating a system that is sustainable, which means that the needs of workers
should take precedent over those of Wall Street.
http://www.dissidentvoice.org/2008/12/every-trick-in-the-book/
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