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It's Time for the Banks to Face the Hangman
by Mike Whitney
 Officials in the Treasury Dept — working with their colleagues at Citigroup, J.P. Morgan and Bank of America — have concocted a scheme to rescue the banks from their massive losses in mortgage-backed securities.
The group is planning to set up a $100 billion emergency fund which will purchase non-performing assets for short term debt. In truth, the fund is a bailout which provides the financial giants with an excuse for not reporting their enormous losses from bad bets.
“How can one defend a system that creates
wealth by making the majority poor?”
- Henry C. K. Liu
The story first appeared in Saturday’s Wall Street Journal and was followed on Monday with a second headline piece:
“RESCUE READIED BY BANKS IS BET TO SPUR MARKET”
WSJ:
“The
high stakes plan to RESCUE BANKS FROM LOSSES on mortgage securities
amounts to a big bet that a consortium of financial giants — AT THE
PRODDING OF THE US GOVERNMENT — can PERSUADE INVESTORS TO POUR MORE
MONEY INTO THE TROUBLED CREDIT MARKET.”
That’s right; the Treasury
Dept is directly involved in a scam that saves the banks while trying
to “persuade” investors to “pour more money” into toxic mortgage-backed
sludge. Treasury Dept officials clearly have a different idea of “moral
hazard” than the rest of us.
The banks are presently holding
hundreds of billions of dollars in mortgage-backed securities (MBSs)
that they cannot sell — because there are no buyers — and don’t want to
take back on their balance sheets because they’ll be forced to increase
their capital reserves. So they’ve decided to launch a public relations
campaign to promote some goofy-sounding fund, called the
“Master-Liquidity Enhancement Conduit” or M-LEC, which will allow the
banks to place their unwanted bonds in Limbo until some future date
when the public appetite for garbage improves.
The WSJ does a
good job of disguising the real motive behind the new “Super-Conduit”
(aka the Bailout fund) but in the last paragraph, buried in Section
C-3, they reveal the truth:
“The goal is to reassure investors and make them more willing to buy its short-term debt.”
So,
the fund is really just a way of rearranging the marketplace until the
next crop of gullible investors sprouts up and buys more
mortgage-backed garbage.
Bloomberg’s Mark Gilbert puts it like this:
“It
seems the way to reassure investors that it's safe to buy the
repackaged junk that has torpedoed credit markets in recent months is
to repackage the least-junky bits of the junk into more palatable
securities. The pyramid just grew another layer.
I can't
decide whether the Treasury's willingness to patronize such a misguided
effort is evidence that the situation is more desperate than anyone
thought, or a positive sign that financial markets will continue to
evolve and innovate and might eventually wrestle the subprime demon to
the ground.”
Indeed.
Where are the regulators? The SEC and
Treasury should be forcing the banks to be straightforward with the
public and let them know about the hanky-panky they’ve been up to with
their risky SIVs (structured investment vehicles) Citigroup alone has
nearly $80 billion in off-balance sheets operations which are in
distress. The bank accounts for “25% of the global SIV market. As of
August, assets held by SIVs totalled $400 billion”.
SIVs are set up as a way to make money without taking the risk onto their balance sheets:
“They
issue their own short-term debt, usually at relatively low rates …then
use the proceeds to buy higher yielding assets such as securities tied
to mortgages.” (WSJ)
Ever since Bear Stearns blew up in late
July, investors have been steering clear of any securities connected to
real estate, which means the SIVs are getting the Double Whammy — they
can’t sell their asset-backed commercial paper (because it’s
mortgage-backed) and they find buyers for their collateralized debt
obligations. (CDOs) To a large extent, the market is still frozen
despite the upbeat cheerleading on the business pages. Clearly, the
worst is yet to come.
How bad is it?
An article in yesterday’s Financial Times said that:
“Only
$9.9 billion of home equity loan securitizations have come to market
since July 1 — A 95% DECLINE FROM THE $200.9 BILLION IN THE FIRST HALF
OF THIS YEAR AND A ROUGHLY 92% DECREASE FROM THE SAME PERIOD LAST
YEAR.”
The banks are in trouble. Big trouble. Main sources of
revenue have dried up overnight and they’re stuck with hundreds of
billions of debt. That’s why the papers broke the story on Saturday
when there was NO chance of triggering a stock market crash.
Imagine
the horror of investors around the world when they discover that the
major investment banks are running these shabby “off-balance sheets”
operations while concealing their real financial condition from their
investors. Consider the disgust the public feels when they see Treasury
officials bailing out the banks instead of ordering them to report
their losses and get on with business.
Still, Wall Street
nonchalantly leaps from one swindle to the next never considering the
damage it’s doing to the credibility of the market.
Susan Pulliam summed it up like this in the Oct 12 edition of The Wall Street Journal:
“Since
the invention of the ticker tape 140 years ago, America has been able
to boast of having the world's most transparent financial markets. The
tape and its electronic descendants ensured that crystal-clear prices
for stocks and many other securities were readily available to
everyone, encouraging millions to entrust their money to the markets.
These days, after a decade of frantic growth in mortgage-backed
securities and other complex investments traded off exchanges, that
clarity is gone. Large parts of American financial markets have become
a hall of mirrors.”
“Hall of mirrors” is an understatement. The
system is thoroughly opaque and crooked as a ram’s horn. The market’s
new architecture, “structured finance”, is a dismal rip-off from start
to finish. Consider the mentality of the hucksters who dreamed up
“securitizing” subprime mortgages and selling them off as precious
jewels in the secondary market. This was a blatant con-job. How can the
liabilities of “borrowers with bad credit” be traded to foreign
investors and pension funds like they were valuable assets? And where
were the regulators while this scam was going on?
Isn’t this sufficient evidence that the system is totally out of whack?
Wall
Street avoids transparency like the plague. That is to be expected. But
what about the government? It’s the government’s job to protect the
investor and maintain the integrity of the system. Is that what
Treasury Dept is doing or are they:
“LURING investors to buy debt issued by the rescue fund as part of the plan”? (quote from the Wall Street Journal)
“Luring”? Is that how Paulson sees it; like luring turkeys to the chopping block with a trail of bread crumbs?
The
idea of protecting the little guy has never occurred to anyone in the
Bush administration. Their job is to shift wealth from one class to the
other via equity bubbles and government bailouts — -anything that
advances the corporate agenda.
Presently, the banks are
sitting on $200 billion in non-performing mortgage-backed securities
(MBSs) and collateralized debt obligations. (CDOs) They are also hold
another $300 billion in collateralized loan obligations (CLOs) from
mergers and acquisitions which stalled after the Bear Stearns meltdown.
If the present bailout doesn’t materialize, we’re likely to see bank
closures and a plummeting stock market.
Shouldn’t the regulators
have considered the probability of a crash before they allowed
trillions of dollars of radioactive-bonds to flood the market when no
one had any idea of their real value? Wouldn’t that have been the
prudent thing to do?
Now we know what they are worth. They’re
worth nothing. That’s why the banks are running scared and refusing to
put them up for auction. They’d rather sleaze them into a
lofty-sounding superfund that masks their true value.
In the
last 2 weeks the stock market soared on the news that the banks were
reporting billions of dollars in losses. Investors were hoodwinked into
believing the banks were being honest and had “come clean” about their
financial condition. What a joke. In reality, the banks only reported
roughly 5% of their potential losses; the rest were hidden in their off
balance sheets operations.
Equities skyrocketed to new heights. Wall Street was euphoric.
Now we know the truth. It was all baloney.
The Wall Street Journal:
“The
new fund is designed to stave off what Citigroup and others see as a
threat to the financial markets world-wide: the danger that dozens of
huge bank-affiliated funds will be forced to unload billions of dollars
in mortgage-backed securities and other assets, driving down their
prices in a fire sale….The ultimate fear: If banks need to write down
more assets or are forced to take assets onto their books, that could
set off a broader credit crunch and hurt the economy. It could make it
tough for homeowners and businesses to get loans.”
It could “hurt the economy” and “make it tough for homeowners and businesses to get loans?”
Ahhh,
yes. It’s all clear now. The banks only cooked up this colossal bailout
to make things better for us common people. How is it that we didn’t
notice that before? Our problem is that we don’t see the magnanimity
and altruism which drives the corporate agenda.
From the New York Times:
“The
conduit (The bailout fund) is expected to start operating in 90 days
and will stay in place for a few years until it has disposed of the
assets it buys, according to people familiar with the negotiations.
To
maintain its credibility with investors from whom it would raising
money, the conduit will not buy any bonds that are tied to mortgages
made to people with spotty, or subprime, credit histories. Rather, it
will buy debt with the highest ratings — AAA and AA — and debt that is
backed by other mortgages, credit card receipts and other assets.”
We
already know about the problems with the ratings agencies and how they
are in bed with the investment banks. We also know that the whole
purpose of the new fund is to off-load mortgage-backed tripe which is
no longer sellable on the market. What we didn’t know is that the New
York Times eagerly provides the peppy public relations narrative to
assist big business in dumping its failing assets.
NY Times:
“The
conduit will pay market prices for the securities it buys. But it
remains unclear how officials will determine the price of some bonds
that have not been actively traded since August, because the difference
between what buyers are willing to pay and what sellers want has
widened significantly.”
Of course, they’ll pay full price
because they want to be “made whole” again. The truth is, however, that
these derivatives will probably only fetch pennies on the dollar unless
they get another Wall Street PR face-lift.
Christian Stracke, market analyst from the research firm CreditSights, said the effort appears to be:
“...an
attempt to soothe tense investors in the debt market, rather than to
provide substantive relief to the worst-hit mortgage securities”.
Stracke added:
“For me, this is more of a P.R. blitz.”
The
announcement of the forthcoming Master-Liquidity Enhancement Conduit or
M-LEC further underlines the gravity of the problems facing the banking
system. The fund creates a “buyer of last resort” so that these dubious
assets won’t be sold on the market at fire-sale prices.
Citigroup
appears to be the greatest beneficiary of the current plan. They have a
number of Enron-type SIVs which could be at risk.
Again, the
problems that are surfacing in the banking sector today are the direct
result of Greenspan’s loose monetary policies coupled with the
dismantling of the regulatory regime that was created following the
1929 stock market crash. We are now back to Square 1. All of the
various scams and swindles which permeated that hyper-inflated market
are now back in full-force foreshadowing a steep decline in investor
confidence, increased market manipulation, and an unavoidable economic
calamity.
“Structured finance” has transformed US markets into
a carnival sideshow. Productivity and real growth have been replaced
with never-ending credit expansion and speculative abuses. Reckless
monetary policies and the behemoth current account deficit have
destabilized the global economy a set the stage for a fiscal
Armageddon.
The subprime mortgage crisis and subsequent
shrinking of asset-backed commercial paper (ABCP) has thrown a wrench
in the funding of daily corporate operations. These are the harbingers
of an impending recession. As mortgages continue to default at a record
pace; the aftershocks will continue to rumble through the credit
markets where subprime loans have been “securitized” into bonds and
leveraged at maximum levels. It’s just one domino knocking down the
next.
The financial system is at greater risk now than any time
in the last 80 years. Regrettably, the only remedies coming from the
Fed are more currency-destroying rate cuts or hundreds of billions of
dollars in repos to remove mortgage-backed bonds from the banks’
balance sheets. Neither of these solutions addresses the critical
issues; they do not stabilize the market, reinvigorate lending, or
restore investor confidence. They are merely band aids on a sucking
chest-wound. They won’t stop the bleeding.
The Fed’s monetary
policies promote financial speculation which inevitably leads to equity
bubbles. Under Greenspan’s stewardship, the country has lurched from
the 1990’s bond bubble, to the dot.com bubble, to the subprime
meltdown, to the liquidity crisis, to the credit crunch — all
engineered at the Federal Reserve with ancillary assistance from the
charlatans in the banking industry.
An article in China Worker, “Credit Crunch threatens Global Downturn” summarizes our present predicament it like this:
“Financial
globalization has rebounded on the system. Capitalist leaders boasted
that the near total integration of financial markets across the globe
would provide lenders and borrowers everywhere with instant access to a
completely liquid money market. New types of financial securities and
sophisticated derivatives would spread the risk of borrowing so widely
that it would eliminate risk entirely. While economies were growing and
bubbles inflating, it appeared that — through derivatives trading —
losses would be widely diffused among speculators, reducing risk to
very low levels.
Not even the most astute financial analysts could
predict what would happen in the event of recession. The unanswerable
question was: Who would ultimately bear the risks arising from
widespread defaults or bankruptcies? The veteran investor, Warren
Buffet, warned that derivatives would prove to be ‘weapons of mass
destruction’.
The fantasy of financial alchemy transforming high risk gambling into low risk money-making has now been shattered.”
The
author is right. “Structured finance” is a fraud. Risk has not been
eliminated. In fact, it has exploded and become a system-wide problem.
The dead wood is everywhere.
The banks are being crushed by a
debt-load they generated through “securitization”. They need to accept
responsibility for their poor judgment (or greed?) and report their
losses. The Super-Conduit is just a dodge to put off the unavoidable
day of reckoning. The whole wretched plan should be scrapped. No amount
of financial chicanery will eradicate billions of dollars in bad bets.
It’s time for the banks to face the hangman.
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