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May 19, 2008

The $800 Billion Bank Shot

The Apotheosis of Deal Making

For Ben Bernanke and the Fed these have been bare knuckle flying days. Never has the dominant central bank moved so radically into a new orbit as has the US Fed this year. Conversely, for the Media this launch into monetary outer space has been greeted with the kind of yawn that might have been reserved for a weather balloon.

Never mind the Bear Stearns rescue that was done so hastily that it appears no one bothered to insist that JP Morgan Chase return future windfalls estimated to be in the billions against guarantees the Fed made to get the deal done in a weekend. The Bear deal did close to end out a very perilous week and what looked like a potential domino game of other falling investment houses --Lehman Brothers was most named as the next-- was stemmed, at least for the time being. This respite, coupled with recent moves up in the markets and the dollar, has gained Bernanke street creds and has kept the flak to a minimum, and directed mainly by capitalist purists, long used to not being listened to. Politically, it also has served as leverage for those who would rescue the millions of underwater adjustable mortgage holders.

While it's true that the Fed's rescue of an important "investment house" crossed a bright historical line, it was also widely recognized that the banking world itself has changed so radically in the last decades as deal making has replaced the sweat and toil of agriculture and manufacturing, that the commercial banks and the investment houses overlap in the kind of credit issued and the kind of paper they accept either as "insurance" or "assets" to back their financing of deals. And it wasn't just Bear and Lehman Bros. etc. who were taking enormous losses, it was also the world's largest "commercial" banks; i.e, Citi, Deutsche, UBS, HSBC, etc. who were announcing multibillion write-downs as far as the eye could see.

The lesson to be drawn is that the Fed and the key European central banks (ECB, BOS, BOE,) have made it abundantly clear that no rash of bad deal making, no matter how egregious the imbalances created are, will be allowed to fail. The Bear deal made headlines, that couldn't be helped but a much more radical plan to create a superfund for bad debt that could go to $800 billion by year's end passed unnoted!

TAF, the Fed's Superfund for Toxic Waste

Last December 17, the Fed announced that it was about to offer US Banks (This was later expanded to include the Bank of Switzerland and the European Central Bank) a deal that they couldn't (and wouldn't) refuse. In exchange for the highly discredited --we prefer the word, toxic--mortgage backed securities on their books, the Fed would offer the banks at face value highly secure US Treasury notes. This deal was called TAF, or Term Auction Facility. In exchange, the Fed charges only 2% --slightly below market, that is, for paper that would probably mark to market at an average discount of 20%-- in interest.

In essence, to get around reserve rules and allow the banks to keep lending, the Fed is taking them off the hook for the bad paper they issued and bought and for the collateral they received from hedge funds that were gambling in the real estate bubble that was fueled by these mortgage backed securities. Remember, the mojo that fueled the rush to lend anybody standing (Chicago voting rolls had better actuaries) with the dough to get into their dream house, came directly from the red hot mortgage backed security and credit swap markets that looked great on the balance sheet of the hedge funds, generated huge annual bonuses for the poo-bahs, and eventually spread as far as the coffers of small towns on the banks of the Norwegian fjords.

So, once again, now that the party is over, the bonuses banked, the private jets furbished and the summer and winter palaces built, the Fed has rushed in to sweep up Wall Street's left over garbage. However, quite significantly, since this was a very big party, even the limits of the US Federal Reserve may be stretched by the time this plays out.

The Fed had been buying up Treasuries for over a hundred years and before this latest rescue operation now in full stride, it had managed to accumulate a war chest of over $800 billion. It's more than a little notable, that by early May, they had already drawn down that pool by more than $150 billion.

In May, Bernanke and crew decided to double down on their bet when they realized that this was not just a mortgage crisis but instead a major debt crisis that includes consumer and student loans as well as automobile credit. To meet the threat that Americans might start walking away from their gas guzzlers and piles of credit card debt, they agreed to expand the definition of eligible paper beyond residential and commercial mortgage backing to anything with a rating above AAA/Aaa asset backed securities. Remember, one of the sub plots of the whole greedy asset-backed security mess, was the way the bond rating agencies decided to jump into the party by trading good ratings for expanded business. In this pool, AAA/Aaa could mean practically anything, even used cars!

Bernanke's big bet is that the failure in the real estate markets will have begun to normalize by the end of the year. And for this to happen he has managed to buy time by putting his $800 billion stake on the table where everyone can see it. For the moment, this has had a calming effect on the stock market and even has slowed the decline of the dollar.

By the end of the year, this hiatus may look more like a pause between storms and if housing prices continue to fall, job losses accelerate and consumers pull way back , it's quite possible Bernanke will have blown the entire pool of Treasurys built up over a century in just a single year. Little wonder, then, that he has given his own encouragement to Congress to move in its rescue of the little guys struggling to hold onto their houses. Too many empty houses on the market could tip the balance.

But there are headwinds that could counter the stimulus that comes from artificially low interest rates, government supported mortgages and a giant green light for bankers to continue to lend. For one thing, a majority of the houses that need rescuing are located in exurban locations. Commuters from these locations where just about everyone has a long commute, often driving the de rigeur SUV or pick-up are getting doubly clobbered as they fill up their tanks and do the weekly supermarket run. Also, a number of the most vulnerable no-money-down mortgage holders were working in the then booming construction industry. In order for prices to even bottom out, new building will remain at a standstill for a long time to come. The combination of a slowdown and the kind of inflation that hurts consumers most, also spells trouble for the commercial building market as company's shrink their staffs. The Fed and Congress's best efforts may not be enough to convince people to keep paying for homes, much less cars, they can't and never could afford.

In CreditWorld, Leverage is King

Most Americans not only do not have savings but most have accumulated large amounts of plastic debt as they attempted to live better even while struggling to keep up wages and pay for health care, fuel and food prices that have only accelerated even as jobs get harder to find.

By lowering interest rates to artificial levels for the second time in five years --to make its TAF subsidy less conspicuous?-- the Fed is also telling savers that they are losers in this new economy. There is little wonder that people who sat on the sidelines while their neighbors were tapping their houses like ATM's now see themselves as the losers. In CreditWorld, it's obvious that Aesop's Tales get flipped upside down.

We have been in bubble mode back since the Keating Five. Since then we have had a succession of bubbles all fanned by Fed policies. We can offer some ideas on what the Fed will sacrifice next to keep the party going one more time.

The Dollar Has No Clothes

Where the buck stops and starts, erosion of the world's preeminent store and measure of value, the US dollar, can serve as a metaphor for the way we grok an expanding, inter-related sphere of critical but slow boiling crises like: energy, health care, population, food, water, climate change, human rights, personal freedom, trade imbalance, wealth division; etc.

FUD and Band-Aids

The dollar is, after all, merely the material meter with which we value all our goods and labors. And yet the precipitous shrinking of this measure, of anywhere between 50 and 150% over the last decade against basic materials has all but escaped mention in the agenda-driven, zeitgeist whirlpool we call the Media. Obviously, once again, it serves no one's agenda to call attention to this inconvenient happening just as it appears to serve no one's interest to understand the consequences of peak oil in an energy driven world economy.

We can offer some "politicized" explanations for the inconvenience, like the cost of a long war to folks who want to expand it to Iran, the war's impact on the price of oil, the insistence on borrowing from foreigners holding excess dollars-- to offset government deficit spending and soak up the overhang from the trade imbalance, the fostering of easy credit needed to jack up the consumer component of the economy to over 70% even as wages stagnate and manufacturing and services are outsourced, the fudging of the CPI to grossly hide inflation and the loosening of controls on how the financial sector can create money.

Here in Dymaxia, we have no magic ways to tap into pools of truth. We are as unarmed as you, dear reader, to insist on what gets talked about on the loud megaphones that, when blared, reach everyone. So, when we try to discern agendas; we mainly revert to the "who stands to gain" approach.

In TV-land we notice there are rarely analysts who insist that borrowing a trillion dollars to fight a war has a negative affect on the value of our currency. There are rarely analysts who make plain that the war in the Persian Gulf is about the control of the flow of petroleum even as it is so completely obvious it sometimes shows up as a slip of tongue by some soon to be sorry politician. There are rarely analysts who make clear that it has been Iran, that has been the greatest beneficiary of our sorry adventure in Mesopotamia. It even took forever for anyone to note that Bush's brain was running on empty even though nobody had ever heard him successfully string three words together.

Time Outs are Ugly

The blogosphere, with all its cacophony, is the repository of an enormous pool of gray matter and hands-on knowledge. One only need think about Wikipedia, warts and all, to grasp its potential to gather information in a cooperative endeavor. But for all its vitality it is a David in the face of a massive Goliath. The whole sorry run-up to the war and the fool me twice rant on the success of the Surge has shown just how a repetitive Media acting in unison can drown out wiser voices.

China, as well as many other more or less totalitarian regimes, has gone further in managing to suppress activity on the Net. Likewise, here in this country, the major internet service providers (led by AT&T and Verizon) have been waging a legislative battle to gain control of the Internet's pipes they manage and parse them into fast lanes (for paid media stuff) and slow lanes (for everybody else). Advocates for Net Neutrality understand that the speed in which a web page, or say, a YouTube clip, is delivered to a browser can ultimately have a major impact on users' preferences for competing info sources. Lest we forget, here's a brief list of YouTube moments that have, for better or worse, had significant weight on this election: Jeremiah Wright's "God Damn America" rant, Hillary's Bosnia misinformation episode, Allan's Macaca Moment (yes, he was an insider conservative pick), McCain's confusion over Sunnis and Shiites, etc.

Ultimately, a sure sign our experiment in democracy is failing is when citizens continue to vote against their best interests. There is, it seems, one tried and true way to make this happen, through cacophony and confusion that elevates wedge issues far above their significance and neutralizes inconvenient facts and truths. Imagine pointing out to people that the price of gasoline or their basic foodstuffs hasn't really gone up so much as the dollars we use to pay for them have gone down. Imagine how that would affect the mass psychology! Instead the story line goes: India and China are now getting richer and they are buying up all our excess petrol, rice and corn. Shouldn't we be wondering how this cosmetic explanation gained such mainstream currency?

Peak Oil?, When's the Last Time You Heard About Peak Oil?

The great issue of our moment, is the nonrenewable fuel crisis. It shapes the most fundamental aspects of our government policies in enormous ways that then need to be obscured by those who would allow us down this --for them very profitable-- path towards the most momentous crash this civilization has ever known. If you look at the War as an extension of our status-quo oil policy, and the cost of maintaining that war at its present inconclusive level and the cost of borrowing to sustain that and factor that in as a direct subsidy to petroleum, the price we really pay per barrel goes ballistic. Now, add in the cost of keeping the Persian Gulf open for shipping, the naval and air power, control and command structures for the region and all the unintended consequences that grow out of our preoccupation with keeping the spigots open, then factor in the burgeoning cost of global warming, not to mention road building and maintenance and you are talking about the greatest subsidy in our history for an ultimately declining industry that will, by the definition of its finiteness, only fail us if we insist on remaining addicted to its supply.

What is worse, as long as we insist upon basing our energy mix around imported oil, we are sending more dollars out of the country into the coffers of the very same countries we feel most threatened by! This, we submit, is collective insanity of the first order and it it doesn't convince you, dear reader, that something very fundamental in the way we process information in this country is entirely broken, then, we suppose, you are reading this for laughs.

Corn to Ethanol, a Metaphor for our Time

It might take chutzpah and confusion to get here but once in Washington, the real money is in the FUD and band-aid businesses: take the current economic crisis-- the product of serial bubbles and across the board excess borrowing from the government down to the lowliest citizen. As a remedy for these excesses, the President announces, without worrying how it might be paid for, that he is sending everybody in the country a check that he promises is sure to kick-start a new recovery to the "slowdown", Congress funds a way for communities to buy up foreclosed properties, the Fed has its back window open soaking up the financial waste products on the books of the major banks and brokerages and it's printing presses running over-time to serve up cheap (when you factor in inflation, interest rates are now negative) money for the next bubble, farmers are paid to turn corn into ethanol even if the process absorbs as much energy as it produces and food shortages pop up around the world, and the Presidential candidates promise programs or further tax cuts, with no way to pay for them. "Got a Problem?, we'll lower a tax!

You might think that this money for nothing, kicks for free approach to solving what is essentially a borrowing crisis, might have raised the curiosity of those who tell the national narrative. How, they might ask, have we found ourselves in the position of facing lower salaries for workers, rapidly rising food prices, gasoline prices that might have showed up in some SUV driver's nightmares a few years ago, and a dollar that is so anemic that travelers abroad have taken to complaining they can't afford un Grand Mac not to mention a coffee and croissant. Watched or not, pots will come to a boil, and now it seems we have come to one of those moments where the steady stream of bubbles in the weak dollar kettle can't be ignored. Of course, as they ignored the rise of CO2 in the atmosphere and its effects, or the decline in ordinary peoples' earning power over the years, the pundit class continues to prate, as if they were playing pin the donkey's tail on their own asses.

Connecting the Dots

First off, there's the unavoidable price at the pump that's brought one of the least enjoyable aspects of traveling in Europe to our own pump islands. You no longer have to imagine paying over 120 bucks to fill up your tank; it's enough it seems to make some people want to give up a job that requires a 150 mile daily commute in their Tundra, if they could only find another. No wonder then, that people are tucking the keys under the Hummer's driver side mat and walking away from that 5000 sq. ft. dream house now 20 or 30% under water, with heating and cooling bills to match.

For that matter, has anyone noticed that while the price of gas was going up, the value of the US dollar was somewhat symmetrically falling when measured against food staples, raw materials, precious metals or even other trading partner currencies like the Euro or Yen?

Of course, we are not on a gold standard, that is, there is no official link between the metal and the dollar but quite curiously we can see that even though the price of oil is actually quoted in dollars, the sellers of that black liquid are getting no more today, if measured in gold, then they did five years ago.



Once upon a time, there were, in more primitive days, political positions that would argue in favor of a weaker or stronger currency. Populists, remember William Jennings Bryant and his famous Cross of Gold speech, would argue for the government to soften its golf restraint to print more money to stimulate growth, Conservatives, with notions of protecting their net worth, argued against the notion. Later it was said that a cheap currency protected both industry and worker by cheapening exports and making imports more costly. Significantly, it was Richard Nixon who broke off the last link between a precious metal --in this case, silver-- and the dollar, thereby making the American printing press, the world printing press. Today, a weak dollar benefits the balance sheets of multinationals who can shift resources in and out of markets and magnify the "growth" of foreign profits by converting them, on paper, at least, into cheaper dollars. For instance, last month, it was Ford's turn to show a profit abroad that magically out-totaled its losses in the US.

For those of us who measure our spending ability in dollars, it is hard today to make the argument that a less valuable dollar has some beneficiary impact. The old saw that currency devaluation acts as a stimulus for export trade has a very hollow ring to a society that has outsourced most of its manufacturing capability to other parts of the world. A low dollar may be helping China and India to establish markets in the "strong" Euro and Yen zones but it has done little or nothing to offset the ever growing trade deficits being run up in this country.

Curiously, outside of Ron Paul's run, none of the present candidates talks about the impact of the dollar's value on all us and so while broadly "the economy" is perhaps the major issue, the role our currency plays appears to get short shrift. Paul, though somewhat coherent, probably has done little to broaden the discussion. By putting a lot of focus on the gold standard, which only rewards gold producing countries, and combining that with an unreal role for government, Paul turns off most progressives and fiscal conservatives who might otherwise be repelled by a weak dollar policy that punishes all of us with savings and earnings in dollars while rewarding multinational corporations that can hedge their holdings abroad and further gimmick earnings.

There are many reasons why the weak dollar has been shut out of the national political discourse by both parties; it's just plain inconvenient since: it makes our assets less valuable in a global economy, it makes it advantageous for players outside the dollar zone to purchase US assets, it tilts corporate power to companies that can do a large part of their business outside the dollar zone and most importantly, it boosts the prices of staples and raw materials where there is global demand. Like the recent rise in oil prices vis √ vis the dollar, the same thing is happening with the price of rice, corn and wheat, the basic food staples the world depends upon. And like petroleum, the food story has a raft of causes. Being somewhat simple in nature and style, we here in Dymaxia, will make the argument that the price of food, like the price of copper, or platinum or uranium has followed closely the ascent of the price of oil (and, of course, the symmetric decline of the dollar).

It's the Dollar, Stupid

We are left to wonder why the two Democratic candidates have not seized on the weak dollar as an argument against McCain and his supply side bromides that will lead to further deficits as far as the eye can see. One supposes they are afraid of being ridiculed the way Paul was made to suffer. Ultimately, this may be a mistake because there is a visceral component to the issue. We in this country are being beggared in order to protect global hegemony for our great global corporate entities. In fact, this is actually and certainly, a potent enough issue, if past currency crises are examples, to be successfully used as an argument for pay as you go government!

Many of the most successful investors over the last six years have bet against the dollar. They looked at the supply-side (debt-fueled) script that Bush was intent on playing out, they looked at the historically unprecedented shift of manufacturing capability out of the US to Southeast Asia that insured an ever increasing trade deficit, they looked at the ensuing shift in demand for basic commodities including food and energy, they looked at the laissez-faire postures coming out of Greenspan's Fed, and finally, once underway, they concluded that the cost of the Iraq War, particularly as it was funded off the books, would further weigh on the dollar, the world's reserve currency.

We are far from our Zimbabwe moment --the rest of the world is paying a price for the weak dollar and will ultimately intervene to support it-- where it takes a wheelbarrow of currency to buy a loaf of bread but we are beginning to see some weird distortions: the price of basic foodstuffs has climbed throughout the world. This is partially due to weather changes, they say --the rice crop in Australia-- and partially due to increasing demand, particularly in Southeast Asia, and partially to the use of corn for ethanol production but also to the decline of the value of the dollar. The US is a major grain producer, a weak dollar would indicate that grain becomes cheaper when purchased outside the dollar zone. This is not the case, of course. Instead, like oil that is also denominated in dollars, food grain prices have climbed as currencies in the raw materials exporting parts of the world have not followed the US dollar down, countries like Canada, Australia and New Zealand.

Because so much of our food is packaged, manufactured product, the raw material component price has not had such a startling impact as say, the price of corn has had on Mexican families who rely on the grain as a key part of their diet. There have been demonstrations in a number of countries beyond Mexico including most recently violence in the streets of Haiti. It is possible then to foresee troubled times around the globe because of a devaluation in the US.

As we've also often noted, paradoxically, the oil rich Arab states, the Chinese and the Japanese have a vested interest in supporting the dollar regime, even as it appears to be falling apart. This is because they are major holders of the dollar in the coffers of their banking systems. They could precipitate a world financial crisis that would make the present leveraged banking crisis feel like a warm breeze in the eye of a hurricane. To be sure, they are all working overtime trying to figure out the least destabilizing ways to lower their dollar positions. We can look for the Chinese, say, to be out seeking stakes in entities that own and control raw material assets and distribution.

Another factor driving the value down is our artificially low interest rates. Money from abroad that might normally flow into the US for safe harbor bond purchases, will instead go to places where interest rates are higher. Today, the rates set by the governing central banks in Europe, Australia, New Zealand and Europe are about where the US was before the Fed rushed in with its record setting cuts. Low interest rates make it cheap for companies to borrow and thus stimulate business activity. What's dismissed is that low rates hurt savers and retirees who have managed to be thrifty and are now living off those savings, even as much as a cheap dollar does. Together, there is a double whammy of inflation and wealth erosion.

Miraculous Recovery

There are some out there who are already heralding that we are on the brink of recovery in the US, even as we are just entering into this Recession. After all, the stock market has performed well this month and the unemployment figures don't seem so bad. Our guess is that unemployment and job loss will be revised upward in the future as they are measured by means that tend to obscure the facts at the outset and end of cycles.

What that would mean is that the financial system has managed to absorb $100's of billions in bad paper, that construction workers who have lost their jobs have some how ended up on their feet, that ordinary Americans, no longer able to borrow against their houses, are bellying up to the bar and paying more for gas and food and still yet are able to keep the 70% of our economy that depends on their consumption on track for growth, that continuing job losses in manufacturing are being replaced elsewhere, that interest sensitive savers are able to absorb the hit of low returns, that high diesel costs are not driving up retail costs and that continuing job shrinkage --we need 150,000+ new jobs per month just to keep pace with population growth-- are all being overcome by some miraculous happenings off the radar somewhere.

Posted by dymaxion at 03:23 PM

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