The Fed is just an Extension of the Banking Establishment; The Bear
bailout proves it -
By Mike Whitney /
19/03/08 "ICH" -- - 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's 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 im****tant psychological affect 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 leader****p 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
re****ts, shows that things are not as they seem. The jubilation is
unwarranted; it's just more smoke and mirrors.
"Lehman Brothers Holdings Inc. re****ted 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 re****ted 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 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 re****t 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 re****ted 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 cl*****
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 re****ts:
"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 re****t 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 im****tant 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" (counterpunch.org) 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 im****ts (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 Treasury and which has actually gone up since
Bernanke began sla****ng 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 ****ge 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.
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