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By Mike Whitney
"It’s a snowball and it keeps getting bigger," Peggy Furusaka, credit specialist at BNP Paribas SA in Tokyo.
Last night, while America slept, investors and dollar-holders around the world held an impromptu election on US stewardship of the global economy. It was a spontaneous referendum triggered by the sudden collapse of Bear Stearns, but it covered many of the issues that have worried investors for the last seven years: the unfunded Bush tax cuts, the $2 trillion war in Iraq, the Federal Reserves low-interest bubble-making policies, the reckless gutting of US industrial base, the $4 trillion increase to the national debt, the multi-billion dollar "no bid" contracts, the opaque deregulated financial system, and the systematic destruction of the world’s reserve currency. The ballots are still being counted, but the outcome is certain. The Bush administration lost in a landslide. Investors have had enough Bush’s failed leadership and the Fed’s reckless, globally-destabilizing monetary policies. A dollar-rout has already begun in earnest and stock markets around the world are plummeting. The Hang Seng index (Hong Kong) fell 4.3 percent to 21,279.40. Japan’s benchmark Nikkei index slumped 3.7 percent to finish at 11,787.51, falling below 12,000 for the first time since August 2005. Shares throughout Europe tumbled overnight, shaving tens of billions off market capitalization. The Fed’s panicky bailout of Bear Stearns and its surprise quarter-point rate cut has ignited a global equities sell-off and sent the cost of protecting corporate bonds through the roof. The economic tsunami is presently right outside New York ready to touch-down on Wall Street at the opening bell. The futures markets are already gyrating wildly. It should be a raucous St Patrick’s day in the Big Apple.
Bernanke’s 11th Hour Bailout of Bear Sparks Market Freefall
In the end, it was a race with the clock. The Federal Reserve wanted to get a deal done before the Asia markets opened hoping to soothe jittery investors and stop a full-blown stock market crash. It was right down to the wire, too. Less than an hour before trading began on Japan’s Nikkei Index, the sale of beleaguered Investment giant, Bear Stearns was announced on Bloomberg News. Backed by a $30 billion line of credit from the Fed, JP Morgan reluctantly purchased Bear for the bargain-basement price of $240 million or $2 per share. Less than a year ago, Bear was riding high at $170 per share, but that was before the credit python had wrapped itself around US financial markets. That seems like ancient history now. Without the Fed’s intervention the nearly-century old investment warhorse would have been dragged from Wall Street feet first. If the deal with JPM had flipped, Bear would have been forced into bankruptcy.
But Bear’s travails are just the beginning of Wall Street’s woes. Now there’s talk of Lehman Brothers going under. According to the Wall Street Journal:
"Worries are deepening that other securities firms and commercial banks might be on shaky ground. Lehman Brothers Holdings Inc. Chief Executive Richard Fuld, concerned about the markets and possible fallout from Bear Stearns’s troubles, cut short a trip to India and returned home Sunday, ahead of schedule, according to people familiar with the matter. The decision came after a series of calls Saturday to both senior executives at the firm and Treasury Secretary Henry Paulson, these people say." ("JP Morgan Rescues Bear Stearns", WSJ)
Mr. Fuld has good reason to be concerned, too. Economics professor Nouriel Roubini says that, "Lehman’s exposure to toxic ABS/MBS securities is as bad as that of Bear: according to Fitch at the beginning of the turmoil Bear Stearns had the highest toxic waste ("residual balance") exposure as percent of adjusted equity on balance sheet; the exposure of Bear was 54.5% while that of Lehman was only marginally smaller at 53.3%; that of Goldman Sachs was only 21%. And guess what? Today Lehman received a $2 billion unsecured credit line from 40 lenders. Here is another massively leveraged broker dealer that mismanaged its liquidity risk, had massive amount of toxic waste on its books and is now in trouble. Again here we have not only a situation of illiquidity but serious credit problems and losses given the reckless exposure of this second broker dealer to toxic investments." (Nouriel Roubini’s Global EconoMonitor)
So, it looks like Bear will be just the first of many over-leveraged investment banks on their way to the chopping block. As credit gets tighter, banks will have to call in their loans to pare down their debts and increase their capital. That’s easier said than done in an environment where consumer’s are cutting back on borrowing and traditional revenue streams have dried up. The banks are facing some stiff headwinds in the near future.
The Federal Reserve announced two initiatives on Sunday designed to "bolster market liquidity and promote orderly market functioning."The Fed is "creating a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York."
This is an incredible move and way beyond the Fed’s mandate to insure price stability. Bernanke is now offering to accept dodgy mortgage-backed bonds from NON-BANK institutions. Outrageous. We can be 100% certain now, that Congress’s closed door meeting on Friday had nothing to do with Bush’s spying on American citizens. Most likely, the Fed convened the meeting to present their extraordinary strategy to save the financial system from a Chernobyl-like meltdown.
The Fed also announced a "decrease in the primary credit rate from 3-1/2 percent to 3-1/4 percent (and) an increase in the maximum maturity of primary credit loans to 90 days from 30 days." (Fed statement)
So Bernanke has not only decided to bailout the banks but everyone else who is even remotely connected to the subprime/securitization swindle. Great. But the rest of the world is not so convinced that this is prudent economic theory, in fact, foreign investors are already shedding US debt instruments faster than any time in history. Let’s hope that Bernanke realizes that foreign Central Banks and investors presently hold $6 trillion dollars of US Treasuries and dollars and can dump it on our shores whenever they choose. That’s enough greenbacks to start a Wiemar-type blizzard that will last until Resurrection Day.
Roubini on the Fed’s plan to provide loans to non-bank institutions:
"By having thrown down the drain the decades old doctrine and rule that the Fed should not lend or bail out non-bank financial institutions the Fed has created an extremely dangerous precedent that seriously aggravates the moral hazard of its lender of last resort support role. If the Fed starts on the slippery slope of providing massive liquidity support to non-bank financial institutions that have recklessly managed their risks it enters into uncharted territory that radically changes its mandate and formal role. Breaking decades-old rules and practices is a radical action that seriously requires a clear public explanation and justification."(Nouriel Roubini’s Global EconoMonitor)
It’s clear that Bernanke is just making it up as he goes along. His actions are unprecedented and, yes, counterproductive. He’s just generating more panic among investors. That doesn’t help. Just a few months ago, Bernanke was reiterating his belief that markets should operate with as little government intervention as possible. What a transformation. Now he has nationalized the banking system and is providing a backstop for privately owned brokerages. What’s next; a bailout for the hedge funds?
There’s still a great deal that we don’t know about the Bear buyout. Like why was it so important to save a bank that had invested its shareholders money so poorly in toxic bonds that were virtually untested in stressful market conditions?
It is complicated, but the real reason for the bailout is that the entire financial industry is now inextricably bound together through multi-billion dollar counterparty transactions called credit default swaps and other unregulated derivatives. When one major player is stricken, the whole system can violently unwind.
According to the Wall Street Journal: "With each firm intricately intertwined with others in a maze of loans, credit lines, derivatives and swaps, the Fed and Treasury agreed that letting Bear Stearns collapse quickly was a risk not worth taking, because the consequences were simply unknowable. ...For Fed officials it was a difficult choice. They did not want to single Bear out for help and they realized their actions aggravated "moral hazard" -- the tendency of bailouts to encourage future risky behavior. But the alternative was potentially far worse. Bear risked defaulting on extensive "repo" loans, in which it pledges securities as collateral for overnight loans from money-market funds. If that happened, other securities dealers would see access to repo loans become more restrictive. The pledged securities behind those loans could be dumped in a fire sale, deepening the plunge in securities prices." ("Fed Races to Rescue Bear Stearns In Bid to Steady Financial System", Wall Street Journal)
So Bernanke felt like he had no choice. He could either bailout Bear or sit back and watch a daisy-chain of defaults take down one bank after another. Of course, there was another option. The Fed and the SEC could have fulfilled their responsibilities as regulators and insisted that derivatives trading come under the purvue of government officials. But, apparently, that was never a serious consideration among the non-interventionist free market cheerleaders at the Federal Reserve. They saw their job as simply enabling their obscenely rich constituents to get even richer while putting the public at risk. Now it has all ended badly.
Saint Patrick’s Day Financial Chainsaw Massacre
In less than an hour, the stock market will open and investors will get a chance to vote on the Fed’s latest plan to rescue the US financial system. Good luck. The dollar has already sunk to $1.59 per euro, gold is up to $1017 per ounce, and oil topped out at $111 per barrel; all record highs. At the same time, foreign investors have begun an informal boycott of US debt. Last week’s auction of US Treasuries was the worst in a decade. Thus, the anemic greenback has continued its steady decline as the fundamentals get weaker and weaker.
This afternoon, at 2PM, President Bush will meet with the Working Group on Financial Markets (aka; the Plunge Protection Team) at private White House meeting. The group includes the Secretary of the Treasury, the Chairman of the Federal Reserve, the Chairman of the SEC, and the Chairman of the Commodity and Futures Trading Commission. The group of financial heavyweights will update the President on developments in the equities markets and explain in greater detail what Henry Paulson calls "the systemic risk posed by hedge funds and derivatives." Of course, by then, the blood could be running knee-deep down Wall Street.
(Note; "Bernankerupted" invented by Mish blogger named skeptic)
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