The Fed's Wall Street Dilemma

By Pam Martens

17/03/08 "Counterpunch" -- - Americans learned two new truths last week from the Bush Administration's version of Life's Little Instruction Book: if you're a Wall Street miscreant you're thrown a lifeline; if you're a Wall Street crime fighter you're thrown a land mine.

In the first effort, the Feds effectively handed a Federal Reserve ATM card to JPMorgan to funnel your tax dollars to the teetering Bear Stearns brokerage firm to address counterparty risks that have been building for at least 4 years as the Feds snoozed. Counterparty risk is the trillions of dollars of insurance contracts (credit default swaps and other derivatives) taken out by Wall Street firms on each others (counterparty) bonds, bundled mortgage and commercial debt (collateralized debt obligations). The firms have used unregulated over-the-counter contracts to perform this risk transfer alchemy and funded their own company, Markit Group Ltd., to take the place of a regulated exchange for price discovery.

In the second effort, the Feds tapped the Department of Justice, Internal Revenue Service, U.S. Attorney's office in New York, FBI, five federal judges and a busy federal court to root out that Code Red threat to our national security: consensual sex. The sex involved a prostitution ring and Democratic New York State Governor, Eliot Spitzer, who was savaged and forced to step down by an avenging media mob abundantly fed with well placed leaks from a suspiciously homogenous group called "anonymous law enforcement officials." Governor Spitzer, in his former role as New York State Attorney General, had taken the lead in rooting out Wall Street crimes against small investors because the Federal Reserve was preoccupied with lobbying to remove regulations on Wall Street's crime factory.

As usual, the Feds handed the bill to the governed with no thought to the will of the governed.

While mainstream media called the Bear Stearns bailout the first brokerage bailout since the Great Depression, in truth it was the second in seven months.

The first brokerage bailout came without all the media fanfare because it arrived not on the wings of a public announcement but in five pages of indecipherable Fed jargon addressed to the General Counsel of Citigroup.

Here is the effective message sent by the Federal Reserve to Citigroup in its letter of August 20, 2007: now that we have allowed you to become both too big to fail and too big to bail by repealing the depression era investor-protection law known as the Glass-Steagall Act at your mere beckoning, we have to bend more rules to keep you afloat. So, for example, the rule that says the Federal Reserve is not allowed to lend to brokerages, just banks, from its discount window can be tweaked for you by lending up to $25 billion to you and then we'll let you lend it to your brokerage arm. The Federal Reserve Act rule that says a bank can't loan more than 10% of its capital stock and surplus to its brokerage affiliate, we'll let you go as high as about 30% and say it's in the public interest.

By giving Citigroup an exemption from Rule 23A of the Federal Reserve Act, by allowing it to funnel up to $25 Billion from the Fed's discount window to its brokerage clients who were getting hit with margin calls, the Federal Reserve and Chairman Ben Bernanke telegraphed an incredibly dangerous message to global markets: we're just as unaccountable as Wall Street. The Federal Reserve as enabler under Alan Greenspan created today's problem and today's Crony Fed under Ben Bernanke is killing off what's left of U.S. financial credibility. (I had barely finished typing these words on Monday, March 17, 2008, when a news alert came across my screen advising that the Federal Reserve was taking the breathtaking step of making direct loans to all brokerage firms which are primary dealers for Treasury securities.)

The Federal Reserve is stumbling around in the dark and regularly bumping into the next bailout because it stopped being an independent monetary force and started taking its marching orders from Wall Street quite some time ago.

Here's what Nancy Millar, President at the time of the National Organization for Women in New York City, presciently testified in writing to the Securities and Exchange Commission in August 2001. (Ms. Millar edited and signed this testimony while I and other Wall Street activists provided input. This testimony is available in full on the SEC's web site.)

We thank the Securities and Exchange Commission for extending the comment period to September 4, 2001 in the critical area of bank oversight now that the lines between banks and brokerage firms have been blurred with the repeal of the Glass-Steagall Act.

We believe that the comments made in the letter dated June 29, 2001 from the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency should be disregarded in their totality. The banks of America have enough lobbyists and trade associations to argue their case before the SEC. It is not the charter or mandate of these three regulatory bodies to lobby on behalf of banks.

The body of evidence that should dictate how the SEC must now proceed since Congress saw fit to eliminate the critical protections afforded the investing public in the Glass-Steagall Act, resides in the tens of thousands of pages of transcripts of the Pujo Committee hearings held in 1913 and the Pecora Committee hearings of 1933 and 1934. Fancy promises from regulators that banks functioning in the dual role as brokerage firms can and will be self-policing is not what the SEC or Congress should rely on. The well-developed history of egregious abuses bestowed on the investing public prior to the enactment of Glass-Steagall, and since its recent repeal, is what the SEC and Congress must look to. To believe that the dynamics of power and greed have been materially altered in nine decades is to engage in naiveté at the public's peril.

Our Nation's prosperity, democracy and the productivity of its citizens demand a level playing field to acquire and safeguard financial assets. Society crumbles when assets achieved through years of honest hard work can be fleeced by brokerage firms masquerading as insured-deposit banks. It is the role of federal regulators to maintain a level playing field through stringent regulation.

We ask that the SEC immediately impose the same regulations that govern outside broker-dealers to securities' operations within banks. And, we herewith ask Congress to reconsider the repeal of the Glass-Steagall Act or be held accountable for the peril that unfolds from this unwise and inadequately deliberated decision.

If ever there was evidence that America is now facing that peril, it was the most recent news that the Bush administration's much touted "free and efficient market" had priced Bear Stearns at $30 a share at the close of trading on Friday, March 14, 2008 but on further examination of its books over the weekend, it was valued at $2 a share and absorbed by JPMorgan at that price.

Equally troubling is the growing awareness among Wall Street veterans that neither the Federal Reserve nor the U.S. Treasury comprehend was has happened here, much less how to contain it. Here's what we heard from Hank Paulson, the Treasury Secretary, last week:

"regulation needs to catch up with innovation and help restore investor confidence but not go so far as to create new problems, make our markets less efficient or cut off credit to those who need it."

Innovation? Less efficient? Is there anything at all that looks innovative or efficient about Wall Street today? It is a seized up house of cards built on a toxic formula of hubris, corruption and free market madness.

Before there is a complete breakdown, Congress must quickly address the five key reasons we have today's mess on our hands:

(1) Incentive: from mortgage brokers paid higher fees to sell subprime loans rather than prime loans, to stockbrokers paid dramatically higher fees to sell mortgage-backed securities rather than U.S. Treasury securities, to investment bankers paid dramatically higher fees to package Collateralized Debt Obligations rather than issue plain vanilla corporate bonds, Wall Street has been incentivized to greed rather than honest service to investors.

(2) Artificial Demand: The above outsized incentive produced a glut of unwanted and unneeded product that had to be eventually hidden off Wall Street's balance sheet in Structured Investment Vehicles (SIVs) or dressed up to look like Commercial Paper and buried in mom and pop money market funds. It is this glut and the lack of transparency as to where else this toxic paper is hiding that is creating the fear and panic on Wall Street.

(3) Counterparty Risk: The regulators allowed Wall Street firms/banks to balloon their asset base and pretend they were meeting capital adequacy tests by buying "insurance" in the form of derivative contracts. There was only one problem with these "hedging" techniques; the counterparty in many cases was just another Wall Street firm or an inadequately capitalized municipal bond insurer. Instead of spreading risk, the risk was concentrated among the same players.

(4) Glass-Steagall Act: Congress was incentivized through Wall Street campaign financing to throw reason and judgment out the window and repeal the only law that stood between the country and another 1929. Glass-Steagall must be restored; and public financing of federal campaigns is the only means of restoring the will of the governed to Washington.

Pam Martens worked on Wall Street for 21 years; she has no securities position, long or short, in any company mentioned in this article. She writes on public interest issues from New Hampshire. She can be reached at pamk741@aol.com

By Mike Whitney

12/01/08 "ICH" --- On Thursday, Fed chairman Ben Bernanke gave the keynote address on the state of the economy and financial markets at a luncheon in Washington, DC. The tone of the speech was decidedly somber and could have easily been accompanied by a funereal dirge and 8 black-suited pall bearers. Bernanke avoided the opaque, hieroglyphic-filled language of his predecessor, Alan Greenspan, and gave a clear presentation of the facts. Unfortunately, the facts are bleak. The economy is in very bad shape.

“Financial market conditions...have produced a volatile situation that has made forecasting the course of the economy even more difficult than usual. (We have seen) continued increases in the prices of energy (as well as) a sharp and protracted correction in the U.S. housing market. According to the most recent available data, housing starts and new home sales have both fallen by about 50 percent from their respective peaks.”

 Bernanke made no effort to conceal the gloomy facts:

“Currently, about 21% of subprime ARMs are ninety days or more delinquent, and foreclosure rates are rising sharply ...Fraud and abusive practices contributed to the high rates of delinquency that we are now seeing in the subprime ARM market, the more fundamental reason for the sharp deterioration in credit quality was the flawed premise on which much subprime ARM lending was based: that house prices would continue to rise rapidly. (This) will have adverse effects for communities and the broader economy as well as for the borrowers themselves.”

  Bernanke was equally blunt about the credit crunch that resulted from the excesses in subprime lending:

  “One of the many unfortunate consequences of these events, which may be with us for some time, is on the availability of credit for nonprime borrowers...The far-reaching financial impact of the subprime shock is that it has contributed to a considerable increase in investor uncertainty about the appropriate valuations of a broader range of financial assets, not just subprime mortgages. (As a result) the problems in the subprime mortgage market may lead overall economic growth to slow.”

  Bernanke went on to give a very detailed account of how the banks “underwrote many of the loans and created many of the structured credit products (MBS, CDOs, ABCP) that were sold into the market. Banks also supported the various investment vehicles in many ways, for example, by serving as advisers and by providing standby liquidity facilities and various credit enhancements.”

  As the problems in subprime have grown, the banks have been forced to take on more and more of their struggling “off balance” sheet operations which dramatically increases their debt-load and further impairs their capital base. This explains why the banks have been reporting huge losses from their deteriorating collateral while their market value has dropped sharply. Now banks have become more restrictive in their lending and credit has become more expensive and less available.

When the banks are unable to issue loans; the economy suffers.

Bernanke added ominously: “The market strains have been serious, and they continue to pose risks to the broader economy.”

  Amen, to that. Since the troubles began in late summer, the Fed has slashed rates by a full percentage point to 4.25% and opened a Discount Window to provide billions of dollars directly to the banks. The Fed has also opened a Term Auction Facility (TAF) which has distributed $40 billion in 30-day repos to over 100 under-capitalized banks. The Fed is planning to loan another $60 billion in the next month. These repos are issued secretly (so depositors and shareholders don't know how bad things really are) and the Fed is accepting a “wide range of collateral”, which means that they are taking "structured investments" (MBSs, CDOs, ASCP) the same garbage that no one will buy on the open-market. In other words, the Fed has established a multi-billion emergency fund which features permanently-rotating loans for banks that made poor investments and are, for all purposes, already bankrupt. This is moral hazard at its absolute worst.

As Bernanke knows, 'permanent-rotating loans' is just a clever euphemism for nationalizing the banks and monetizing their debts at the taxpayers' expense. Many of these institutions are already insolvent. The Fed is just ensuring that there are no consequences for their leveraged bets and reckless speculation. Once again, it's socialism for the rich and capitalism for the poor.

But even these unprecedented measures do not really solve the basic problems of credit quality or the serious constraints on lending. For that, the Fed will have to aggressively slash rates hoping to revive the sagging economy.

Here's Bernanke's grim (but realistic) forecast:

“Financial conditions continue to pose a downside risk to the outlook for growth....The financial situation remains fragile, and many funding markets remain impaired. Adverse economic or financial news has the potential to increase financial strains and to lead to further constraints on the supply of credit to households and business...Incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced. Notably, the demand for housing seems to have weakened further, in part reflecting the ongoing problems in mortgage markets. In addition, a number of factors, including higher oil prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008.”

“The baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become more pronounced.” That says it all. We're headed into recession and it's going to be a doozy.

Bernanke's assessment is only slightly different from the bleakest predictions of the doomsday web sites. Unemployment is on the rise which will continue to be a drag on consumer spending. Inflation is also likely to be a concern as the Fed slashes rates and food and energy prices go through the roof. Even so, the listless economy is so hobbled by the collapse in real estate and the subsequent meltdown in the financial markets, that the Fed will be forced to ease rate by at least 50 basis points at the next Board of Governors meeting followed by further cuts all the way down to 2.5%. (According to Goldman Sachs and Merrill Lynch) If that's the case, we can expect to pay 4 to 5 dollars for gas by the end of 2009.

Although Bernanke's candor is a welcome relief from Greenspan's circuitous “Fed-speak”, his dark prognosis does little to address the problems facing the markets. It's hard to tell whether we are entering a new era of Fed transparency or if Bernanke has simply taken the attitude that “When all else fails; tell the truth”. That's hardly a sign of personal virtue.

 The bad economic news is now cascading-down from all sides. The dollar is steadily weakening which sent gold to a new-high of $900 on Friday. Hours earlier, the Commerce Department reported that the trade deficit had skyrocketed 9% to $63.1 billion in November. That puts more pressure on the greenback as foreign investors will  continue to flee the US to markets with greater growth-potential.

 Also, the nation's largest brokerage firm, Merrill Lynch is expected to report losses of $15 billion on soured mortgage-backed securities. The nation's largest bank, Citigroup, is expected to report even bigger losses of $25 billion on similar investments. The nation's largest mortgage-lender, Countrywide, will (allegedly) face bankruptcy if Bank of America's $4 billion bid for the ailing company is not accepted. And, the nation's largest bond insurer,MBIA Inc., may need to raise $10 billion in capital to keep its AAA credit rating. (said William Ackman, president of Pershing Square Capital Management)

  Get the picture? The giants of the financial industry are either on the brink of annihilation or they have joined the long conga-line of haggard CFOs who are on their way to Beijing with begging bowl in hand. Battered banks and corporations are increasingly forced to get capital in the only place it is still available; China and the oil producing countries. Thus, the life's-blood of capitalism now surges through a communist artery. How's that for irony?

  On Friday, the RBC Cash Index reported that consumer confidence had fallen to an all-time low. The US consumer is over-extended, underpaid, and worried about everything from his soaring energy bills, to diminishing job security, to the mass foreclosures. The report was released just hours before the Dow Jones Industrial Average took a 246 point swan-dive in heavy trading. The prevailing mood on Wall Street is gloomy and the feeling is that the worst is yet to come. Judging by the extraordinary steps taken by the Fed; we could be facing a Force 5 fiscal-hurricane.

Economic soothsayer Doug Noland summed it up like this:

“The Mortgage Finance Bubble is a bust, Wall Street finance is imploding, and foreign financial institutions are keen to cut and run from the business of providing U.S. Credit... Worse yet, the economy is quickly succumbing to recessionary forces. With a high degree of confidence we can proclaim that the Mortgage Crisis has now evolved into a Corporate Debt Crisis – and this crisis will not be resolved anytime soon – by rates, by helicopters, or by bailouts.” (Doug Noland “Mortgage Crisis to Corporate Debt Crisis”, Prudent Bear)

  Thanks for your honesty, Ben, but all the exits appear to be bolted-shut. We'll have to ride this storm out from inside the bunker.

July 5, 2006

The Veep's Curious Investment Portfolio

Is Cheney Betting On Economic Collapse?

By MIKE WHITNEY

Wouldn't you like to know where Dick Cheney puts his money? Then you'd know whether his "deficits don't matter" claim is just baloney or not.

Well, as it turns out, Kiplinger Magazine ran an article based on Cheney's financial disclosure statement and, sure enough, found out that the VP is lying to the American people for the umpteenth time. Deficits do matter and Cheney has invested his money accordingly.

The article is called "Cheney's betting on bad news" and provides an account of where Cheney has socked away more than $25 million. While the figures may be estimates, the investments are not. According to Tom Blackburn of the Palm Beach Post, Cheney has invested heavily in "a fund that specializes in short-term municipal bonds, a tax-exempt money market fund and an inflation protected securities fund. The first two hold up if interest rates rise with inflation. The third is protected against inflation."

Cheney has dumped another (estimated) $10 to $25 million in a European bond fund which tells us that he is counting on a steadily weakening dollar. So, while working class Americans are loosing ground to inflation and rising energy costs, Darth Cheney will be enhancing his wealth in "Old Europe". As Blackburn sagely notes, "Not all bad news' is bad for everybody."

This should put to rest once and for all the foolish notion that the "Bush Economic Plan" is anything more than a scam aimed at looting the public till. The whole deal is intended to shift the nation's wealth from one class to another. It's also clear that Bush-Cheney couldn't have carried this off without the tacit approval of the thieves at the Federal Reserve who engineered the low-interest rate boondoggle to put the American people to sleep while they picked their pockets.

Reasonable people can dispute that Bush is "intentionally" skewering the dollar with his lavish tax cuts, but how does that explain Cheney's portfolio?

It doesn't. And, one thing we can say with metaphysical certainty is that the miserly Cheney would never plunk his money into an investment that wasn't a sure thing. If Cheney is counting on the dollar tanking and interest rates going up, then, by Gawd, that's what'll happen.

The Bush-Cheney team has racked up another $3 trillion in debt in just 6 years. The US national debt now stands at $8.4 trillion dollars while the trade deficit has ballooned to $800 billion nearly 7% of GDP.

This is lunacy. No country, however powerful, can maintain these staggering numbers. The country is in hock up to its neck and has to borrow $2.5 billion per day just to stay above water. Presently, the Fed is expanding the money supply and buying back its own treasuries to hide the hemorrhaging from the public. Its utter madness.

Last month the trade deficit climbed to $70 billion. More importantly, foreign central banks only purchased a meager $47 billion in treasuries to shore up our ravenous appetite for cheap junk from China.

Do the math! They're not investing in America anymore. They are decreasing their stockpiles of dollars. We're sinking fast and Cheney and his pals are manning the lifeboats while the public is diverted with gay marriage amendments and "American Celebrity".

The American manufacturing sector has been hollowed out by cutthroat corporations who've abandoned their country to make a fast-buck in China or Mexico. The $3 trillion housing (equity) bubble is quickly loosing air while the anemic dollar continues to sag. All the signs indicate that the economy is slowing at the same time that energy prices continue to rise.

This is the onset of stagflation; the dreaded combo of a slowing economy and inflation.

Did Americans really think they'd be spared the same type of economic colonization that has been applied throughout the developing world under the rubric of "neoliberalism"?

Well, think again. The American economy is barrel-rolling towards earth and there are only enough parachutes for Cheney and the gang.

The country has lost 3 million jobs from outsourcing since Bush took office; more than 200,000 of those are the high-paying, high-tech jobs that are the life's-blood of every economy.

Consider this from the Council on Foreign Relations (CFR) June edition of Foreign Affairs, the Bible of globalists and plutocrats:

"Between 2000 and 2003 alone, foreign firms built 60,000manufacturing plants in China. European chemical companies, Japanese carmakers, and US industrial conglomerates are all building factories in China to supply export markets around the world. Similarly, banks, insurance companies, professional-service firms, and IT companies are building R&D and service centers in India to support employees, customers, and production worldwide." ("The Globally integrated Enterprise" Samuel Palmisano, Foreign Affairs page 130)

"60,000 manufacturing plants" in 3 years?!?

"Banks, insurance companies, professional-service firms, and IT companies"?

No job is safe. American elites and corporate tycoons are loading the boats and heading for foreign shores. The only thing they're leaving behind is the insurmountable debt that will be shackled to our children into perpetuity and the carefully arranged levers of a modern police-surveillance state.

Welcome to Bush's 21st Century gulag; third world luxury in a Guantanamo-type setting.

Take another look at Cheney's investment strategy; it tells the whole ugly story. Interest rates are going up, the middle class is going down, and the poor dollar is headed for the dumpster. The country is not simply teetering on the brink of financial collapse; it is being thrust headfirst by the blackguards in office and their satrapies at Federal Reserve.

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