Monday, March 31, 2008

US Fed – the Black Hand in America

Like everything in our past, the late American president, John Fitzgerald Kennedy exists as a memory. Struck down by an assassin in a decade where bullets—democracy’s deadly equalizer—quieted those brave enough to champion change, eg: JFK, Martin Luther King and Robert Kennedy, President John Fitzgerald Kennedy were true American heroes, while a champion to many are by definition, a threat to some.

America’s problems after 1950 mirrored England’s descent from power one century before. America’s problems didn’t go unnoticed by those who then led the US Presidents Dwight D Eisenhower and his successor, John F Kennedy. The reaction of each, however, is a chilling reminder of the dangers facing those who rule.

President Dwight D Eisenhower was Supreme Commander of the Allied Forces that defeated the fascist powers in World War II; and as a war hero, he was believed to be an ideal candidate for the Republican Party in the 1952 presidential elections.

While serving as president, Eisenhower clearly saw the forces that would someday be responsible for America’s loss of power; for it was during Eisenhower’s presidency that the erosion of America’s economic wealth began.

Prior to Eisenhower’s presidency in 1952, the US was the wealthiest nation in the world. As the largest industrial power, the US enjoyed a positive balance of trade with its partners. Before Eisenhower assumed office, the US had gold reserves totaling almost 22,000 tons, the most gold any nation had ever possessed.

When Eisenhower left office, however, it is uncertain how much gold remained; because after 1954 the US never allowed a public audit of its gold reserves. As the US then sold more goods abroad than it bought, US gold reserves should have increased. Instead, they declined. In one year alone, 1958, US gold reserves were reduced by 10 %.

The powerful forces that controlled America were spending so much of America’s wealth on overseas military and corporate expansion, that gold was flowing out faster than trade could bring it in. The profligate spending responsible for America’s loss of gold and consequent debt began during Eisenhower’s presidency.

“I place economy among the first and most important republican virtues, and public debt as the greatest of the dangers to be feared. To preserve our independence, we must not let our rulers load us with perpetual debt.” President Thomas Jefferson (1743-1826)

Only days before leaving office, in his Farewell Speech Eisenhower named those he believed responsible for the policies that would someday endanger America’s liberties and render this once wealthy nation financially insolvent.

“In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.”

“…We cannot mortgage the material assets of our grandchildren without risking the loss also of their political and spiritual heritage. We want democracy to survive for all generations to come, not to become the insolvent phantom of tomorrow.”

Less than fifty years after Eisenhower uttered those prophetic words, America’s patrimony is gone and its future mortgaged beyond its ability to repay. His words were heard but not heeded—not then or since. It cannot be said that America wasn’t warned. It can and will be said that America didn’t listen.


It is no coincidence that Eisenhower waited until three days before leaving office to warn America about the US military-industrial complex. A military man himself, Eisenhower felt it necessary to warn the country of the unwarranted influence and intrusion of military and industrial [sic business] interests that were then colluding to hijack the future liberties and prosperity of America.

Eisenhower’s warnings were not conclusions he had reached just before his presidency ended. They were conclusions Eisenhower had reached during his eight years as president, years spent observing how the business of government was conducted and who profited by its activities.

Eisenhower knew that even as President of the US, he did not possess the requisite power to openly oppose the powerful interests that were even then spending the US into insolvency. So President Eisenhower waited until the very end of his last term to warn America of the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex.

Eisenhower was right not to openly challenge the military-industrial complex. The man who succeeded Eisenhower as president, John F Kennedy, did. But those who wield the real power behind the government’s facade of democratic fair and equal rule were not to be trifled with then. They are not to be trifled with now.


“The real rulers in Washington are invisible, and exercise power from behind the scenes.” US Supreme Court Justice, Felix Frankfurter

US President Woodrow Wilson also spoke of the real rulers in Washington DC decades before Eisenhower and Kennedy were to encounter them. In his preface to The New Freedom: A Call For The Emancipation Of The Generous Energies Of A People, Wilson wrote:

“Since I entered politics, I have chiefly had men's views confided to me privately. Some of the biggest men in the United States, in the field of commerce and manufacture, are afraid of somebody, are afraid of something. They know that there is a power somewhere so organized, so subtle, so watchful, so interlocked, so complete, so pervasive, that they had better not speak above their breath when they speak in condemnation of it.”

These are not words of an imprudent man. They are the words of a US President who cared enough about his country to warn of the dangers lurking behind its illusory facade of law, liberty, justice and equality for all...Dangers of which Americans were unaware of then—and of which the vast majority are still unaware of now.


John F Kennedy was not to live out his first term as President. Three years into his presidency, JFK was felled by an assassin’s bullet in Dallas, Texas. While there is much controversy surrounding his death, it is clear that whatever the theory, it was no accident.

The assassination of a standing president is not undertaken lightly. The public killing of a highly popular political figure such as JFK is decided upon and agreed to only when sufficient amounts of money or power are at stake.

Previous theories have revolved around issues of power. Dissident and/or dissatisfied rogue CIA agents and/or right-wing Washington DC power brokers and/or the mafia conspiring separately or together in a mutual hatred for the upstart Kennedy have been the favored theories. Another, simpler theory, however, should also be considered—money.

On June 4, 1963, Executive Order 1110 was signed by President Kennedy directing the US Treasury to issue a new US currency. This new US currency was to be backed by a precious metal—silver, unlike the credit-backed money issued by the Federal Reserve since 1913.



By virtue of the authority vested in me by section 301 of title 3 of the United States Code, it is ordered as follows: (Y)
SECTION 1. Executive Order No. 10289 of September 19, 1951, as amended is hereby further amended- (a) By adding at the end of paragraph 1 therefore the following subparagraph (j): n" (j) The authority vested in the President by paragraph (b) of section 43 of the Act of May 12, 1933 as amended (31 U.S.C. 821 (b), to issue silver certificates against silver bullion, silver, or standard silver dollars in the Treasury not then held for redemption (X) of any outstanding silver certificates, to prescribe the denominations of such silver certificates, and to coin standard silver dollars (Z) and subsidiary silver currency for their redemption, and (b) By revoking subparagraphs (b) and (c) of paragraph 2 thereof. SECTION 2. The amendment made by this Order shall not affect any act done, or any right accruing or accrued or any suite or proceeding had or commenced in any civil or criminal cause prior to the date of this Order but such liabilities shall continue and may be enforced as if said amendments had not been made. John F Kennedy, The White House, June 4, 1963

By the stroke of a pen, President Kennedy’s signing of Executive Order 1110 returned the power to issue currency back to the US Treasury thereby ending the fifty year monopoly of private bankers and the Federal Reserve Bank over US currency. Six months later, President John F Kennedy was shot and killed.

In 1913, as a result of intense lobbying by business and banking interests, the US government had turned over the power to issue US currency to a group of private bankers—the Federal Reserve Bank. Many believe this transfer was unconstitutional. US presidential candidate and Congressman Ron Paul (ranking member of the House Subcommittee on Domestic Monetary Policy) has stated:

“The United States Constitution grants to Congress the authority to coin money and regulate the value of the currency. The Constitution does not give Congress the authority to delegate control over monetary policy to a central bank. Furthermore, the Constitution certainly does not empower the federal government to erode the American standard of living via an inflationary monetary policy.”

The power to coin money and regulate the value of the currency is among the most important responsibilities and functions of government. That the US government in 1913 turned over this public function to a group of private bankers is astounding.

As a consequence, almost one hundred later, the US and its citizens are now on the edge of bankruptcy, indebted up to their eyeballs to the very bankers they gave the power to coin their money and regulate their currency, private bankers who are even now being bailed out by America taxpayers with money made available to them by their fellow-bankers at the Federal Reserve.


For almost one hundred years in America, private bankers through the Federal Reserve Bank have had a monopoly on the printing and issuance of US currency. In that time they have inflated the US money supply to such a degree the US dollar has lost 95 % of its purchasing power and again brought the nation to the edge of economic ruin.

In 1963, fifty years after the Fed acquired the right to print, issue and inflate the money supply of the US, President John F Kennedy quietly transferred that power back to the US Treasury, the only institution which the constitution had granted the power to coin and regulate currency. Rest assured that transference did not go unnoticed by the private bankers and the Fed.

US Presidential candidate Ron Paul has introduced legislation during each Congress to abolish the Fed (H.R. 2755 - 110th Congress, HR 2778 - 108th Congress, HR 5356 - 107th Congress, HR 1148 - 106th Congress). His inability to attract congressional support, however, is in all likelihood his Washington DC life insurance policy.

“…we have in this country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve Banks. The Federal Reserve Board, a Government board, has cheated the Government of the United States and the people of the United States out of enough money to pay the national debt. These twelve private credit monopolies were deceitfully and disloyally foisted upon this country by the bankers who came here from Europe and repaid us for our hospitality by undermining our American institutions...The people have a valid claim against the Federal Reserve Board and the Federal Reserve banks.” Congressman Louis T McFadden, Chairman of the House Committee on Banking and Currency from 1920–31


US Plan would expand Fed's power to intervene in financial crisis March 29, 2008

WASHINGTON (CNN) -- The Federal Reserve would have the power to regulate virtually the entire financial industry under a Treasury Department proposal to be announced Monday.

The proposal is part of a sweeping overhaul of the government's regulatory structure that Treasury Secretary Henry Paulson will propose in a speech Monday, said Treasury Department spokeswoman Michele Davis.

"I am not suggesting that more regulation is the answer, or even that more effective regulation can prevent the periods of financial market stress that seem to occur every five to 10 years," Paulson will say, according to a text of the speech obtained by The Associated Press.

According to Brookly McLaughlin, another department spokeswoman, Paulson will propose these changes:

•Give the Federal Reserve authority to look at the financial status of any institution that could affect market stability;
• Merge the Securities and Exchange Commission with the Commodity Futures Trading Commission;
• Give stock exchanges more room for self-regulation;
• Consolidate bank supervision into one regulator.

One of the most dramatic changes would extend the powers of the Federal Reserve, designed to regulate the commercial banking industry, to oversight of virtually the entire financial industry.


After the recent collapse of Bear Stearns, the Fed announced that US funds will now be made available to international investment banks. Previous to this announcement, any loaning of US funds to investment banks was prohibited.

On March 28th, the first day the funds were available, the Fed loaned the banks $75 billion dollars. These investment banks, called primary-dealers, are the inner circle of the Fed’s funding mechanism.

That these primary-dealers are in need of US support is an indication of the rapidly disintegrating state of their balance sheets—and the lengths the Fed will go to protect their fellow bankers in the private sector with public money.


BNP Paribas Securities Corp
Banc of America Securities LLC
Barclays Capital Inc
Bear, Stearns & Co, Inc
Cantor Fitzgerald & Co
Citigroup Global Markets Inc
Countrywide Securities Corp
Credit Suisse Securities (USA) LLC
Daiwa Securities America Inc
Deutsche Bank Securities Inc
Dresdner Kleinwort Wasserstein Securities LLC
Goldman, Sachs & Co
Greenwich Capital Markets, Inc
HSBC Securities (USA) Inc
J P Morgan Securities Inc
Lehman Brothers Inc
Merrill Lynch Government Securities Inc
Mizuho Securities USA Inc
Morgan Stanley & Co Inc
UBS Securities LLC

The bailout of the richest investment banks in the world by US taxpayers is tantamount to a kidnap victim being forced to defray their kidnappers’ expenses. Someday, however, these bail-outs by the Fed will come to an end, but that end will not be pretty—for the end of central banking will be both unprecedented and brutal.

Central banks and investment banks are two sides of the same coin; and, now that the coin has been debased and recast with subprime securities and other suspect forms of debt; investment banks and their enablers, the central banks, are as vulnerable as those they once exploited.

Their increased vulnerability will soon be triggered by any number of events, eg: bank insolvencies, collapsing currencies, slowing economies, money-market failures, counter-party derivative defaults etc, each one powerful enough to bring down a faltering house of cards built on a foundation of rapidly shifting sand.


The US military-industrial complex is still too powerful to confront and/or stop. With the bankers, they are responsible for America’s increasingly insolvable problems, their self-interests blinding them to what they have done to the nation.

Eisenhower couldn’t stop them, neither could Kennedy nor can Ron Paul. Only they can stop themselves and this they will soon do; albeit inadvertently as the foundation of their power, the US economy, succumbs to the damage they have inflicted upon it.

The economic carnage set in motion by government’s pact with private bankers will affect everyone—workers, savers, entrepreneurs, investors, pensioners, the helpless, as well the innocent and the guilty. Yes, bankers, too, will lose at least some of their wealth, if not all.

Everyone everywhere will be affected by the collapse of debt-based central banking. The economic landscape is already shifting as global credit markets implode. Bankers—the parasites of commerce and productivity—are now victims of their own excessive greed. Their demise will affect us all.

The torrent of collapsing debt accumulated and compounded since the beginning of central banking is about to be unleashed on an unsuspecting world. All beginnings have endings. So, too, does debt-based central banking.


Today, our governments and leaders are reassuring us that our pensions and investments are safe, that they have the tools and resources needed to protect us from the economic chaos threatening our financial futures, that there is no reason to panic.

But America will panic, and there will be blood in the streets and years of misery. Because this must all end!

A $1 Trillion Write-Down Lurks

Be it ever so devalued, $1 trillion is a lot of dough.

That's roughly on a par with the Russian economy. More than double the market value of Exxon Mobil Corp. About nine times the combined wealth of Warren Buffett and Bill Gates.

Yet $1 trillion is the amount of defaults and write-downs Americans will likely witness before they emerge at the far side of the bursting credit bubble, estimates Charles R Morris in his shrewd primer, “The Trillion Dollar Meltdown.” That calculation assumes an orderly unwinding, which he doesn't expect.

“The sad truth,” he writes, “is that sub-prime is just the first big boulder in an avalanche of asset write-downs that will rattle on through much of 2008.”

Expect the landslide to cascade through high-yield bonds, commercial mortgages, leveraged loans, credit cards and -- the big unknown -- credit-default swaps, Morris says. The notional value for those swaps, which are meant to insure bondholders against default, covered about $45 trillion in portfolios as of mid-2007, up from some $1 trillion in 2001, he writes.

Morris can't be dismissed as a crank. A lawyer, former banker and author of 10 other books, he knows a thing or two about the complex instruments that have spread toxic debt throughout the credit system. He once ran a company that made software for creating and analyzing securitized asset pools. Yet he writes with tight clarity and blistering pace.

The financial innovations of the past 25 years have done some good, Morris notes. Collateralized mortgage obligations, invented in 1983, saved homeowners $17 billion a year by the mid-1990s, according to one study.

Slicing and Dicing

CMOs transformed the business by slicing pools of mortgages into different bonds for different risk appetites. Top-tier bonds had the first claim on all cash flows and paid commensurately low yields. The bottom tier was the first to absorb all the losses; it paid yields resembling those on junk bonds.

What began as a good thing, though, soon spawned a bewildering array of new asset classes that spread throughout the financial system, marbling balance sheets with what Morris calls inflated valuations, hidden debt and “phony triple-A ratings.” The more the quants fine-tuned the upper tranches of CMOs and other collateralized debt obligations, the more dangerous the bottom slices grew. Bankers began calling it “toxic waste.”

Guess where the toxins wound up? That's right: Credit hedge funds are now the weakest link in the chain, Morris says. Their equity stands at some $750 billion and is so massively leveraged that “most funds could not survive even a 1 percent to 2 percent payoff demand on their default swap guarantees,” he writes.

Utter Thrombosis

Morris sketches a scenario in which hedge fund counter-party defaults would ripple through default swap markets, triggering write-downs of insured portfolios, demands for collateral, and a rush to grab cash from defaulting guarantors. The credit system would suffer “an utter thrombosis,” he says, making the sub-prime crisis“ look like a walk in the park.”

As bankers and regulators try to prop up an unstable “Yertle-the-Turtle-like tower of debt” Morris points to two previous episodes of lost market confidence.

The first was the 1970s inflationary trauma that prompted investors to suck money out of the stocks and bonds that finance business. Confidence returned only after Fed chief Paul Volcker slew runaway inflation by ratcheting up interest rates.

The other precedent is the popped 1980s Japanese asset bubble. In that case, politicians and finance executives tried to paper over their troubles. Two decades later, Japan still hasn't recovered, Morris writes.

We should be as bold as Volcker, he suggests: Face the scale of the mess, take a $1 trillion write-down and shore up regulatory measures. His recommendations include forcing loan originators to retain the first losses; requiring prime brokers to stop lending to hedge funds that don't disclose their balance sheets; and bringing the trading of credit derivatives onto exchanges.

What he fears is that the US will instead follow the Japanese precedent, seeking to “downplay and to conceal. Continuing on that course will be a path to disaster.”

Wednesday, March 19, 2008

The Banker’s Banker

The Fed is just an Extension of the Banking Establishment, as the Bear Bailout Proves.

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 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 effect 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 the 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” ( 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 Treasuries which have 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.

Sunday, December 23, 2007

Dirty Laundry

Since the 1600s, there have been five occasions when major worldwide financial crises have occurred, and they all used securitization of credit:

The 1637 Tulip-mania bubble was based on a market in tulip futures, securitized with personal credit notes.

The 1721 South Sea Bubble was securitized by shares of the South Sea company, a company operating in South America.

The 1789-1795 bankruptcy of the French monarchy was securitized by "assignats," bills of credit based on lands confiscated from the clergy.

The Panic of 1857 was securitized by railway shares.

The 1929 Wall Street crash was securitized by stock shares, and by bonds from well over 100 foreign countries. This is described in "The bubble that broke the world."

Today of course we're securitizing credit by turning subprime mortgages and other questionable credit into credit derivatives and CDOs.

We're now overdue for the next generational crash. It could happen tomorrow, next week, next month or next year, but it's coming soon.

Will we see a stagflation, a recession or a depression?

It will be an era of severe depression, worse than the 1930s, with massive unemployment, bankruptcies, homelessness and starvation.

Can something like "circuit breakers" prevent a panic?

"Circuit breakers" are used by the stock markets to try to control a panic. If the market loses, say 15% in one day, then the market closes for a few hours, to let people catch their breath.

Unfortunately, circuit breakers are useless.

A generational crash is an elemental force of nature, like a tsunami.

There will be millions or even tens of millions of Boomers and Gen-Xers in countries around the world, never having seen anything like this before, and not having believed it was even possible, suddenly in a state of total mass panic, trying to sell all at once.

Computer systems will crash or will be clogged for hours, or perhaps even for a day or two. People who had hoped to get out just as the collapse is occurring will be totally screwed, and will lose everything. Brokers and other institutions will go bankrupt. People who went short hoping to make a fortune will find that their brokers' escrow accounts are gone, and they'll be totally screwed, and will lose everything.

Being in the market today, either short or long, is a very high risk proposition.

What's a credit crunch, and what's going on?

The easiest way to understand it is this.. The world's money is disappearing. Everday there's less money in the world than the day before. Since there is less available, it's harder to get money, unless you're willing to pay high interest rates to get it. Hence, there is a "credit crunch."

One result is that banks are hoarding money, and are increasingly reluctant to lend money to one another or to other businesses. This means that even legitimate, credit-worthy individuals and companies are having a hard time getting credit, getting mortgages, or getting loans without having to pay extremely high interest rates.

How could there possibly be less money in the world?

It's not that people are eating dollar bills for lunch.

In fact, paper money is pretty irrelevant these days. Very little money is created by means of printing presses today. Money is created by means of credit. When a central bank (like the Fed or the Bank of England) wants to create more money, it doesn't run the printing presses, but simply lowers the short-term inter-bank lending rate, so that there'll be more credit, hence more money.

Unfortunately, financial institutions found that they can use a technique called "leveraging" to create money from credit, essentially going around the powers of the central bank. They create a new security and tell you that it's worth $10, but they'll let you buy it for $1 and loan you the other $9. So $10 that didn't exist before now does, a magical 'printing press' re-invented.

These securities are called "credit derivatives", and among them are CDSs (credit default swaps) and CDOs (collateralized debt obligations).

The credit bubble has created $750 Trillion in notional value credit derivatives. Are those credit derivatives the same as money? Not exactly. You can't go into the grocery store and pay for your groceries with a credit derivative.

But you CAN use those credit derivatives in your portfolio as collateral for a loan, and then you can use THAT money to buy groceries. So in fact the credit derivatives do create money.

That's what's been happening up until July of this year. But suddenly people are discovering that the security that was supposedly worth $10 is really worth only $5 or $2 or even $1, and sometimes they're totally worthless. So the process of creating money is now going in reverse. Instead of money being created through credit, today money is being destroyed through the unwinding of the credit bubble.

How much money has been destroyed since July?

A huge amount already. Let's start with an example.

Things really started moving in mid-July, when Bear Stearns announced that its hedge funds were practically worthless. That's because the hedge funds were these CDOs that had been magically created, and were supposedly worth several billion dollars. Well, they discovered that nobody wanted to buy them, and if nobody buys them, then they have no market value when they're "marked to market."

Since then a number of financial institutions have "gone to the confessional" explaining they too have lost a great deal of money in write-downs because their portfolios contained worthless CDOs. These are major financial institutions like Citigroup, Merrill Lynch, Morgan Stanley, Goldman Sachs and JPMorgan Chase.

Citibank tried to save itself by means of a fraudulent scheme known as a "Master-Liquidity Enhancement Conduit (M-LEC)." Under the scheme, Citibank and other banks would sell worthless CDOs to each other at inflated prices in order to establish a phony "market price" for the CDOs. Citibank's fraudulent M-LEC idea didn't take off, forcing the bank to take $16.4 Billion in write-offs of worthless CDOs. Citibank might have gone bankrupt except it was saved by an investment by the Abu Dhabi Investment Authority.

These big financial institutions are announcing more every day, and mainstream estimates vary as high as $500 Billion in write-downs.

So now that $500 billion is gone. That's money that existed a few months ago, but no longer exists, and that's how money gets destroyed.

And that's only the large institutions. We've hardly heard from the small institutions, but we're beginning to. State and local governments in Florida and Montana have to freeze their investment pools because the pools were found to have invested in near-worthless CDOs. And that's the tip of the iceberg. There are tens of millions more small and medium-sized institutions around the world that are going to have similar situations, forcing them to write-down these securities.

With $750 Trillion of notional credit derivatives in the world, it would not be surprising if the total write-down amounts to $7.5 Trillion (1%) or even $75 Trillion (10%).

Is that all?

Hardly. Because next you have the De-leveraging problem.

When a bank has $1 Million in assets available, it can loan out 5 or 10 times as much as that, or $5-10 Million. That's leveraging.

But if the $1 Million in assets suddenly disappears, then there's $5-10 Million that it can't loan out any more. That's De-leveraging.

The point of all this is that there's MUCH less money in the world today, and there's less and less everyday.

What do sub-prime mortgages have to do with all this?

For the most part, residential sub-prime mortgages were the original "seeds" for the credit explosion. Banks started requiring less and less from people wanting mortgages, and by the time it was over, anyone could get a mortgage for any amount, with no problems, even if they had no assets, no income, no job, and no hope of even making the mortgage payments.

These mortgage loans, like any other form of credit, created new money. That new money could then be leveraged into credit derivatives that were worth 5-10 times as much as the original mortgage loans. Those credit derivatives could then be leveraged further. This process would continue several times.

However, there were other "seeds" as well. Requirements for credit cards and other forms of credit were also relaxed, so that people could get credit that way as well. Delinquencies have been rising in credit cards, car loans, student loans, even business loans, just as they have in mortgage loans.

Why would banks make loans to people who couldn't pay them back?

Because the banks made money that way, lots of it. The loan officers made commissions from the loans. I'd be happy to lend you $1 Million of someone else's money if I got a $50,000 commission from it, and that's what happened. That's what happened with mortgage loans, with credit card loans, with car loans, with student loans, business loans, and so forth.

And then the financial geniuses got hold of the loan contracts and turned them magically into CDOs with phony notional prices. They sold those, and got even more in hefty commissions from selling them.

So basically along the way, Wall St bankers were loaning out other people's money, and taking fat commissions for themselves.

Isn't that illegal?

You're damn right it's illegal. And I can hardly wait to see some of these financial geniuses get put away.

I've been studying this stuff for awhile now, trying to figure out what's going on.

At first I thought that people were just being naïve or stupid.

But I've since come to the conclusion that the mess that we're in was done on purpose -- by contemptuous and nihilistic Gen-Xers taking advantage of air-head Boomers too dumb to work the numbers on their investment portfolios.

The point is that a lot of people have committed crimes, and they're going to well-deserved jail cells.

What's a "structured investment vehicle" (SIV)?

This is one of the gimmicks that the financial geniuses created. Their objectives were to collect huge commissions for themselves, while defrauding the general public with securities that they knew had to become almost worthless. The SIV is part of that.

When banks issue these CDOs, they aren't issued by the bank itself. Instead, the bank creates a new "virtual" bank called a "structured investment vehicle." All the "financial magic" is done within the SIV, so that if something goes wrong, the original bank had nothing to do with it. That's called "keeping structured securities off-balance sheet" of the original bank, a phrase you see often in the press.

However, the same people are involved in both the original bank and the SIV, and so they still PERSONALLY collect the same huge commissions, often in the millions of dollars.

To understand these, it helps to understand the structure of an SIV -

First an SIV has investors - like hedge funds, or wealthy individuals who invest say $1 Billion in the SIV. Then the SIV issues commercial paper (CP) and medium-term notes (MTN) that pay slightly higher rates than similar duration paper. The typical SIV according to Fitch, uses 14 times leverage, so in our example the SIV would sell CP and MTN for $14 Billion.

Now the SIV invests this $15 Billion ($1 Billion equity and $14 Billion borrowed) in longer term notes. The idea is simple: borrow short, lend long, hedge the interest rate and credit risks - and the profits flow to investors in the SIV.

What happens when the CP comes due and no one wants to buy any more? To cover the CP, the SIV might have to sell the longer term assets at a steep discount, and this would trigger a liquidation of the entire SIV. To prevent this "fire sale", the sponsoring banks stepped up and provided financing to cover the expiring CP.

And just so we know who we're talking about here: When it says "the SIV has investors like hedge funds or wealthy individuals" -- that's a little misleading. Because the investors also include ordinary people's pension funds and so forth. I don't think that the people of Florida would consider themselves "wealthy individuals," now that their investment pool contains SIV funds that must be written down.

The last paragraph above is the reason why banks have been forced to write-down SIV funds: no one wants to buy the commercial paper anymore, once the Bear Stearns hedge funds collapsed in July. And they've been desperately using every trick they could play to keep the fraud going by avoiding the "fire sale" as long as possible.

What part do rating agencies play?

The three ratings agencies -- Standard & Poor's, Moody's Investors Service and Fitch Ratings colluded with the banks to defraud the public, as Bloomberg news accused on June 30.

While the bankers were taking fat commissions for themselves, they were also making fat payments to the ratings agencies to provide AAA ratings on the CDOs in the SIVs. This was an essential part of the scheme.

Take, for example, the Florida investment pool we've been talking about. The people who ran that pool didn't know which securities were good and which were questionable. They just depended on the ratings from the rating agencies. And one of their internal rules is that the pool could invest ONLY in AAA securities.

So if the bank managers pay the ratings agencies to provide AAA ratings on the questionable securities in the SIVs, then Florida and anyone else could invest in them without even asking any questions. The bankers would get their fat commissions, the ratings agencies would get their fat fees, and the investors would be the only ones getting screwed.

And there is NO CHANCE WHATSOEVER that these agencies didn't know what they were doing.

Sure, maybe the first few deals really were OK. But as time went on, and the rules were bent more and more, there could have been NO DOUBT in the minds of these bankers and ratings agencies that they were defrauding the public.

After Bloomberg accused the ratings agencies of fraud on June 30, they knew they had to change. Since then, they've been re-rating many of the SIV securities, sometimes lowering their ratings as many as 10 or 20 levels lower than the original AAA rating. That's what happened to many of the securities that the Florida investment pool had invested in, and that's why they're currently facing a financial crisis.

Hey, who's minding the ship here anyway? Was everyone, all the way to the 'top' cashing in on this fraud?

The answers will come as this credit crunch unwinds, exposing all the dirty laundry on Wall Street, and possibly right up through the political administration in the US itself. Of this, I have no doubts!