FedUpUSA

Archive for February 8th, 2011

This about covers it all.  Pay close attention and understand this.  It’s important.

STOP THE LOOTING & START PROSECUTING!

How to Make $4 Trillion Vanish in a Flash

On August 9, 2007, an incident took place at a bank in France that touched-off a financial crisis that that would eventually wipe out more than $30 trillion in capital and thrust the world into the deepest slump since the Great Depression. The event was recounted in a speech by Pimco’s managing director Paul McCulley, at the 19th Annual Hyman Minsky Conference on the State of the U.S. and World Economies. Here’s an excerpt from McCulley’s speech:

“If you have to pick a day for the Minsky Moment, it was August 9. And, actually, it didn’t happen here in the United States. It happened in France, when Paribas Bank (BNP) said that it could not value the toxic mortgage assets in three of its off-balance sheet vehicles, and that, therefore, the liability holders, who thought they could get out at any time, were frozen. I remember the day like my son’s birthday. And that happens every year. Because the unraveling started on that day. In fact, it was later that month that I actually coined the term “Shadow Banking System” at the Fed’s annual symposium in Jackson Hole.

“It was only my second year there. And I was in awe, and mainly listened for most of the three days. At the end….I stood up and (paraphrasing) said, ‘What’s going on is really simple. We’re having a run on the Shadow Banking System and the only question is how intensely it will self-feed as its assets and liabilities are put back onto the balance sheet of the conventional banking system.’”

BNP had been involved in credit intermediation, that is, it was exchanging bonds made up of mortgage-backed securities (MBS) for short-term loans in the repo market. It all sounds very complex, but it’s no different than what banks do when they take deposits from customers and then invest the money in long-term assets. (aka–”maturity transformation”) The only difference here was that these activities were not regulated, so no government agency was involved in determining the quality of the loans or making sure that the various financial institutions were sufficiently capitalized to cover potential losses. This lack of regulation turned out to have dire consequences for the global economy.

It took nearly a year from the time that subprime mortgages began to default en masse, until the secondary market (where these “toxic” bonds were traded) went into a nosedive. The problem was simple: No one knew whether the underlying mortgages were any good or not, so it became impossible to price the assets (MBS).  This created, what Yale Professor Gary Gorton calls, the e coli problem. In other words,  if even a small amount of meat is contaminated,  millions of pounds of hamburger has to be recalled. That same rule applies to mortgage-backed securities. No one knew which MBS contained the bad loans, so the entire market froze and trillions of dollars in collateral began to fall in value.

Subprime was the spark that lit the fuse, but subprime wasn’t big enough to bring down the whole financial system. That would take bigger ructions in the shadow banking system.  Here’s an excerpt from an article by Nomi Prins which explains how much money was involved:

“Between 2002 and early 2008, roughly $1.4 trillion worth of sub-prime loans were originated by now-fallen lenders like New Century Financial. If such loans were our only problem, the theoretical solution would have involved the government subsidizing these mortgages for the maximum cost of $1.4 trillion. However, according to Thomson Reuters, nearly $14 trillion worth of complex-securitized products were created, predominantly on top of them, precisely because leveraged funds abetted every step of their production and dispersion. Thus, at the height of federal payouts in July 2009, the government had put up $17.5 trillion to support Wall Street’s pyramid Ponzi system, not $1.4 trillion.” (“Shadow Banking”, Nomi Prins, The American Prospect)

Shadow banking emerged so that large cash-heavy financial institutions would have a place to park their money short-term and get the best possible return.  For example, let’s say Intel is sitting on $25 billion in cash. It can deposit the money with a financial intermediary, such as Morgan Stanley, in exchange for collateral (aka MBS or ABS), and earn a decent return on its money. But if a problem arises and the quality of the collateral is called into question, then the banks (Morgan Stanley, in this case) are forced to take bigger and bigger haircuts which can send the system into a nosedive. That’s what happened in the summer of 2007. Investors discovered that many of the subprimes were based on fraud, so billions of dollars were quickly withdrawn from money markets and commercial paper, and the Fed had to step in to keep the system from collapsing.

Regulations are put in place to see that the system runs smoothly and to protect the public from fraud. But banking without rules is more profitable, so industry leaders and lobbyists have tried to block the efforts at reform.  And, they have largely succeeded.   Dodd-Frank – the financial reform act — is riddled with loopholes and doesn’t really resolve the central issues of loan quality, additional capital, or risk retention. Banks are still free to issue bogus mortgages to unemployed applicants with bad credit, just as they were before the meltdown. And, they can still produce securitized debt instruments without retaining even a meager 5 per cent of the loan’s value. (This issue is still being contested) Also, government agencies cannot force  financial institutions to increase their capital even though a slight downturn in the market could wipe them out and cause severe damage to the rest of the system. Wall Street has prevailed on all counts and now the window for re-regulating the system has passed.

President Barack Obama understands the basic problem, but he also knows that he won’t be reelected without Wall Street’s help.  That’s why he promised to further reduce “burdensome” regulations in the Wall Street Journal just two weeks ago. His op-ed was intended to preempt the release of the Financial Crisis Inquiry Commission’s (FCIC) report, which was expected to make recommendations for strengthening existing regulations. Obama torpedoed that effort by coming down on the side of big finance. Now, it’s only a matter of time before another crash.

Here’s an excerpt from a special report on shadow banking by the Federal Reserve Bank of New York:

“At the eve of the financial crisis, the volume of credit intermediated by the shadow banking system was close to $20 trillion, or nearly twice as large as the volume of credit intermediated by the traditional banking system at roughly $11 trillion. Today, the comparable figures are $16 and $13 trillion, respectively…..The weak-link nature of wholesale funding providers is not surprising when little capital is held against their asset portfolios and investors have zero tolerance for credit losses.” (“Shadow Banking”, Federal Reserve Bank of New York Staff Report)

So, between $4 to $7 trillion vanished in a flash after Lehman Brothers blew up. How many millions of jobs were lost because of inadequate regulation?  How much was trimmed from output, productivity, and GDP? How many people are on now food stamps or living in homeless shelters or struggling through foreclosure because unregulated financial institutions were allowed to carry out credit intermediation without government supervision or oversight?

Ironically, the New York Fed doesn’t even try to deny the source of the problem; deregulation. Here’s what they say in the report: “Regulatory arbitrage was the root motivation for many shadow banks to exist.”

What does that mean? It means that Wall Street knows that it’s easier to make money by eliminating the rules….the very rules that protect the public from the predation of avaricious speculators.

The only way to fix the system is to regulate all financial institutions that act like banks.  No exceptions.

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

CounterPunch

This is ugly….

1/31/2006   25,645,896,285.90
1/31/2007   27,336,683,880.94
1/31/2008    8,835,629,723.80
1/30/2009  -67,799,617,875.20
1/29/2010  -32,713,679,545.20
1/31/2011  105,835,837,302.30

Oops.

This is the January actual operating deficits in terms of debt increase or decrease by Treasury.

Just looking back to 2006 there’s a real problem here.  January is normally a good month for the deficit because the last estimated payment is due; ergo, we should have lower deficit numbers.

The bad news is that if this trend continues we’re going to blow the $1.7 trillion numbers from last calendar year with some authority.  As I pointed out in my annual Ticker, we are on a path toward a $2 trillion deficit this calendar year, and I have no expectation, and neither should you, that we’ll get away with that.

This much is certain: The government has been lying about intentions on deficits forever.  We have now run three years consecutively where we have said we’ll stabilize and then start dropping the deficit, and instead we have gone the other direction.  The argument for short-term stimulus must have a “use-by” date, and yet we simply refuse to stamp a date on it, instead saying “we’ll do it until employment returns.”

What if employment does not come back because the deficit spending and government mandates are causing continued unemployment by forcing input cost ramps that squeeze producers?

That’s something you should contemplate carefully, because if this is anything close to accurate then we’re going to go right down the toilet while screaming but it will get better – I promise!

The time to learn from our mistakes and stop the insanity is quickly running out.

The Market-Ticker

Well, it was nice while it lasted.  One of the really good things that came out of the recent economic downturn was that millions of American families decided to get out of debt.  In particular, we had seen a sustained trend of reduced credit card usage in the United States.  It looked like Americans had finally wised up.  But we should have known that Americans would not be willing to tighten their belts forever.  Unfortunately, it appears that getting out of debt is no longer so “trendy”.  In fact, the month of December was the third month in a row in which consumer credit grew in the United States.  Prior to that, consumer credit in the United States had declined for 20 months in a row.  The American people were doing so, so good.  Why did they have to stop?  It appears that the American people have fallen off the wagon and have gotten a taste for credit card debt once again.  This time, however, the credit card companies are back with interest rates that are higher than ever.  In fact, one national credit card company has hundreds of thousands of customers signed up for a card that charges interest rates of up to 59.9%.

59.9%?

You mean there are people that are stupid enough to actually sign up for a credit card that will charge them 59.9% interest?

Unfortunately the answer is yes.

In fact, the top rate was 79.9% before First Premier Bank lowered it.

These cards are targeted at Americans that have a poor credit history, and these days there are a whole lot of those.

A recent story on the website of CNN described how large numbers of U.S. consumers with poor credit are gobbling up credit cards like these.  Unfortunately, many of these consumers are also not smart enough to realize what they are getting into.  The CNN story contained a quote from a woman who was in complete shock when she discovered that her interest rate was going to go up by 50 percentage points….

“I about had a heart attack when I got a disclosure notice saying that my starting rate of 29.9% was going up to 79.9%.”

First Premier Bank has since lowered the top rate on those cards to 59.9%, but that it still completely outrageous.

Not only are the interest rates on those cards super high, but they also charge a whole bunch of fees on those cards as well.  The following are some of the fees that First Premier Bank charges….

*$45 processing fee to open the account

*Annual fee of $30 for the first year

*$45 fee for every subsequent year

*A monthly servicing fee of $6.25

So you would think that nobody in their right mind would ever sign up for such a card, right?

Wrong.

CNN is reporting that almost 700,000 Americans have signed up for the card.

Ouch.

In fact, CNN says that First Premier Bank gets between 200,000 to 300,000 new applications a month for the card, but that they only open about 50,000 new accounts each month.

Are there really this many Americans that are this gullible?

If Americans would just remember the “DBS” rule they would be so much better off.

DBS = Don’t Be Stupid

Do you know how long it would take to pay off a credit card with a 59.9 percent interest rate?

Just a 20 percent interest rate is bad enough.

According to the credit card repayment calculator, if you owe $6000 on a credit card with a 20 percent interest rate and only pay the minimum payment each time, it will take you 54 years to pay off that credit card.

During that time you will pay $26,168 in interest rate charges in addition to the $6000 in principal that you are required to pay back.

Ouch!

The number one piece of financial advice that most of the “financial gurus” give is that you should get out of credit card debt – particularly credit card debt that has a high interest rate.

Unfortunately, 46% of all Americans carry a credit card balance from month to month today.

According to the United States Census Bureau, there are approximately 1.5 billion credit cards in use in the United States.

 Of U.S. households that have credit card debt, the average amount owed on credit cards is $15,788.

This is how the bankers enslave us.

We end up paying them 3, 4 or even 5 times as much as we originally borrowed.

Month after month after month we slave away to make them wealthy.

So how do you stop this vicious cycle?

You quit buying stuff that you can’t afford!

Unfortunately, the vast majority of Americans have never received any formal training on how to manage finances.

Most of us were never taught any of this stuff in school.  Most of us were totally unprepared when the financial predators started preying on us in college.  Most of us got sucked in and spent years and years trapped in credit card debt.

When you carry a balance from month to month you are willingly signing up to become a debt servant to the big banks.  They get rich while you suffer.

The sad thing is that the mainstream media is pointing to increased credit card spending as a sign that the U.S. economy is getting back to normal.

But gigantic mountains of debt is what got us into all of this trouble in the first place.

Average household debt in the United States has now reached a level of 136% of average household income.

In China that figure is only 17%.

Obviously, we have a massive, massive problem with debt in this country.

Cranking the debt spiral back up is not going to cause the economy to recover.

Well, the profits of the big banks might recover, but the rest of us will suffer.

If you want to be financially free, then it is time to pay off your credit card debt and get off the debt payment treadmill for good.

The entire global economy is on the verge of collapse, so now is a great time to renounce consumerism.  Instead, we need to be preparing ourselves and our families for the hard times that are coming.

The Economic Collapse

Of course nobody will be listening….

In an earlier post, I wrote that Congress should act immediately to abolish credit default swaps on the United States, because these derivatives will foment distortions in global currencies and gold. Credit defaults swaps on the United States currently settle in euros, but there is talk of creating new contracts calling for settlement in gold. Congress should immediately ban all credit derivatives on the United States, since the opportunities for mischief making outweigh the hedging value.

In my opinion Congress should ban any and all securities for trading by any regulated entity (such as banks, hedge funds, mutual funds and similar) that are not exchange-traded.  Not clearinghouse-listed, exchange traded.

Why?

Because it is my considered opinion that such instruments as CDOs and custom, bespoke CDS have as one of their key elements to their marketability obfuscation of who holds what risk, why they hold the risk, and under what terms they will need to pay.

How much mayhem could “creative” minds generate in the credit default swap markets, the currency markets, and the gold market? Quite a bit, since customized credit default swaps can be embedded in all manner of financial investments, and they can be written to offload unexpected risks on naïve investors.

The Dodd-Frank “financial reform” bill doesn’t address customized over-the-counter credit default swaps, and the bill doesn’t do anything at all to reign in speculation in the currency markets or the commodities markets.

That “omission” was intentional.  The simple fact of the matter is that these highly-customized contracts are extremely profitable for the banks and other large financial institutions.  But the basic laws of business balance prohibit these artifices from being profitable unless someone is able to hide their true characteristics. 

The clear and obvious fact is that nobody works for free.  Therefore, the more-complex a security is, and the more hands it touches, the worse the deal for the customer.  There is no way around this.  The only way you can have these deals be “better” for the customer is if someone gets rooked or the customer is wrong about what he thinks the “better deal” constitutes. 

You always have a right to take a less-advantageous deal for yourself, but nobody does of their own free will.  The only time this sort of thing ever happens is if someone is deceived.  That is, they take a risk they didn’t know they had, or they’re convinced to lend someone money at terms that look attractive but that’s only true because the risk they believe they’re accepting is different – and less - than the risk they actually accept.

This is what made loans like OptionARMs, the custom Abacus CDOs and similar instruments possible.  Were the customers to understand what they were buying they would have never bought.  Customers were mollified by worthless “ratings”, the pronouncements of various actors such as lending officers and other alleged “professionals” and in some cases outright fraud such as the cases where a consumer had his or her income changed by a lending officer to pass some computer-driven ratio.

One can argue that these acts should be prosecuted, and I both have and will continue to.  But looking forward rather than in the rear-view mirror the only way to stop this is to bar the creation and trading of these instruments.  If whatever we trade is forced onto an exchange then there is no chain risk and there is no hiding of the sausage.  With exchange trading everyone can see the best bid and offer, we know what open interest is, and there is never a question as to the mark on that instrument – it’s right there, “in your face” every trading day.

Janet talks about Central Bankers having a “bubble deflator”, and that the financial industry has once again found a way to play without adult supervision.  She’s right in her analysis of the implications, but the better option is to not allow instruments to be offered that are intentionally-complex for the purpose of deceiving people in the first place.

The Market-Ticker