A Generalized Meltdown of
Financial Institutions
MIKE
WHITNEY
Counterpunch
Sunday November 25, 2007
Reality has finally caught
up to the stock market. The American consumer is underwater, the
banks are buried in dept, and the housing market is in terminal
distress. The Dow is now below its 200-Day Moving Average -- the
first big "sell" signal. Anything below 12,500 could trigger
program-trading and crash the market. The increased volatility
suggests that we are watching a "real time" meltdown.
International Business editor for the UK
Telegraph, Ambrose Evans Pritchard, summed up yesterday's action in
the Asian markets:
"The global credit crisis has hit
Asia with a vengeance for the first time, triggering a massive
flight to safety as investors across the region pull out of
risky assets. Yields on three-month deposits in China and Korea
have plummeted to near 1pc in a spectacular fall over recent
days, caused by panic withdrawals from money market funds and
credit derivatives.
"'This' is a severe warning sign,'
said Hans Redeker, currency chief at BNP Paribas. 'Asia ignored
the credit crunch in August but now we're seeing the poison
beginning to paralyze the whole global economy.'" (Credit 'Heart
attack' engulfs China and Korea" Ambrose Evans Pritchard,UK
Telegraph,)
The credit storm that began in the
United States with subprime mortgages has spread to markets across
the globe. In fact, the train has already crashed. What we're seeing
now is the boxcars piling up on top of each other.
On Tuesday Chinese government officials
ordered a complete halt to bank lending to slow the speculative
frenzy that has created an enormous equity bubble in the stock
market. According to the Wall Street Journal:
"Chinese authorities are slamming
the brakes on bank lending, in their latest attempt to curb the
runaway investment threatening to overheat what is soon to be
the world's third-largest economy. In recent weeks, regulators
have quietly ordered China's commercial banks to freeze lending
through the end of the year, according to bankers in several
cities. The bankers say that to comply, they are canceling loans
and credit lines with businesses and individuals." ("China
freezes lending to Curb Investing Frenzy" Wall Street Journal)
The move illustrates how
concerned the Chinese are that a slowdown in US consumer spending
will trigger a crash on the Shanghai stock market. It also shows
that the Chinese are having difficulty dealing with the inflation
generated by the hundreds of billions of US dollars absorbed via the
trade imbalance with the US. China is awash in USDs and that surplus
is causing a steady rise in food and energy costs. This could be
mitigated by allowing their currency to "float" freely. But a
sudden, steep increase in the Chinese yuan's value could also send
the world headlong into a global recession. For now, the lending
freeze and price fixing appear to be the way out.
Another sign that the markets have
reached a "tipping point" appeared in a Reuters article on
Wednesday; "Interbank Covered Bond Trading Halted on Volatility":
"Renewed credit turmoil and
volatility led the European Covered Bond Council (ECBC) on
Wednesday to suspend inter-bank market-making in covered bonds
until Monday, Nov. 26.
The move is a sign of the stress in
the covered bond market, which is dominated by German
institutions that have almost a trillion euros of covered bonds
outstanding.
Covered bonds -- backed by pools of
assets that remain on the borrower's balance sheet -- are
usually highly liquid and typically rated triple-A by ratings
agencies. The ECBC's recommendation is aimed at relieving the
pressure on market makers who are forced to quote prices at a
fixed bid-offer spread.
"In light of the current market
situation and in order to avoid undue over-acceleration in the
widening of spreads, the 8-to-8 Market-Makers & Issuers
Committee recommends that inter-bank market-making be
suspended," the ECBC said in a release."
Note: This isn't mortgage-backed junk
that's being sold, but highly liquid bonds that are usually easy to
cash in. The ECBC's action is a sign of pure desperation and
indicates that credit paralysis has infected the entire euro banking
system.
Reuters: "Due to general market
conditions and the specific mechanics of the inter-dealer market
making it even seems possible that inter-dealer market making will
not be resumed this year."
That's bad. The mechanism for converting
covered bonds into cash has broken down.
The dollar took another pasting on
Wednesday, sliding to $1.49 on the euro; another new record. Gold
shot up to $814 per ounce. Oil continues to flirt with the $100 per
barrel mark, and the yen rose to 107 per dollar forcing a sell-off
of hedge fund assets levered through the carry trade.
Jon Basile, economist at Credit Suisse,
summed it up like this: "There's a heck of a lot of bad news out
there." Indeed.
In California Governor Arnold
Schwarzenegger has joined with four mortgage lenders to freeze
adjustable interest rates (ARMs) for some of the state's
highest-risk borrowers; another unprecedented move. The Governor
hopes to avoid a collapse of the California real estate market which
has gone into a tailspin. Home sales have plummeted more than 40 per
cent for the last two months. Prices have dropped sharply---roughly
12 per cent statewide. New construction has slowed to a crawl.
Layoffs are steadily rising. Jumbo loans (mortgages over $417,000)
have been put on the "Endangered Species" list. Even qualified
borrowers can't get mortgages. Nothing is selling. California
housing is "off the cliff".
Schwarzenegger's plan to keep
over-extended subprime mortgage-holders in their homes faces an
uncertain future. What incentive is there for homeowners to continue
paying exorbitant monthly rates when their payments are not applied
to the principle? The homeowners would be better off bailing out,
accepting foreclosure, and starting over with a clean slate.
It's unrealistic to thinks that
Schwarzenegger can stop the tidal wave of foreclosures that are
sweeping across the state. An estimated 3 million homeowners will
lose their homes nationwide.
If you want to blame someone; blame Alan
Greenspan. He's the one who created this mess. According to the
economist Mike Shedlock:
"The Fed caused the
credit crunch by slashing interest rates to 1 per cent to bail
out its banking buddies in the wake of a dotcom bubble collapse.
All the Fed did was create a bigger bubble. This bubble is so
big in fact that it cannot even be bailed out. It's the end of
the line for a serially bubble blowing Fed.
"So not only was this the biggest
credit bubble in history, this was also the biggest transfer of
wealth from the poor and middle class to the already enormously
wealthy. That is the real travesty of justice regardless of
whether or not the price tag is $1 trillion, $2 trillion, or $10
trillion." (Mike Shedlock, "Mish's Global Economic Trend
Analysis")
The problem has gotten so serious that
even Secretary of the Treasury, Henry Paulson, is putting up red
flags. Last week, Paulson ignited a sell-off on Wall Street when he
made this statement:
"The nature of the problem will be
significantly bigger next year because 2006 [mortgages] had
lower underwriting standards, no amortization, and no down
payments....We're never going to be able to process the number
of workouts and modifications (to mortgages) that are going to
be necessary doing it just sort of one-off. I've talked to
enough people now to know that there's no way that's going to
work."
The desperation is palpable. Like
Schwarzenegger, Paulson is trying to get mortgage-lenders to provide
a safety net for struggling borrowers who are defaulting on their
loans.
Paulson is calling for emergency
legislation that will allow the Federal Housing Administration to
play a greater role in the relief effort. The FHA has already
expanded its traditional role by taking on hundreds of billions in
extra debt just to keep a few "private" mortgage lenders and banks
from going bankrupt. Of course, when Paulson's plan goes kaput and
the debts pile up; it'll be the taxpayer that foots the bill.
"Paulson also called the Senate's
failure to pass legislation overhauling mortgage giants Fannie
Mae and Freddie Mac frustrating," saying that the two
government-sponsored entities need to be playing a bigger role
in the housing market.
"If we ever need them it's during
times like today, and they're most valuable when there is
distress in the mortgage market," he said. "I'd like to see them
playing an even bigger role."(Wall Street Journal)
Fannie and Freddie, have already posted
enormous quarterly losses and don't have the capital reserves to put
millions of subprime mortgage-holders under their
"government-sponsored" umbrella. Paulson is just grabbing at straws.
Similar troubles are brewing in the
broader market where late-payments and defaults have spread to
credit card debt and new car loans. Every area of "securitized" debt
has suddenly veered off the road and into the ditch. Last week the
Fed injected more credit into the teetering banking system than
anytime since 9-11.
No one has predicted the downward-spiral
in the market more accurately than Nouriel Roubini. Roubini is a
Professor at the Stern School of Business at New York University.
His analysis appears regularly on his blogsite, Global EconoMonitor.
Last week's prediction was particularly dire and is worth reprinting
here:
"It is increasingly clear by now
that a severe U.S. recession is inevitable in next few
months...I now see the risk of a severe and worsening liquidity
and credit crunch leading to a generalized meltdown of the
financial system of a severity and magnitude like we have never
observed before. In this extreme scenario whose likelihood is
increasing we could see a generalized run on some banks; and
runs on a couple of weaker (non-bank) broker dealers that may go
bankrupt with severe and systemic ripple effects on a mass of
highly leveraged derivative instruments that will lead to a
seizure of the derivatives markets... massive losses on money
market funds with a run on both those sponsored by banks and
those not sponsored by banks; ..ever growing defaults and losses
($500 billion plus) in subprime, near prime and prime mortgages
with severe knock-on effect on the RMBS and CDOs market; massive
losses in consumer credit (auto loans, credit cards); severe
problems and losses in commercial real estate...; the drying up
of liquidity and credit in a variety of asset backed securities
putting the entire model of securitization at risk; runs on
hedge funds and other financial institutions that do not have
access to the Fed's lender of last resort support; a sharp
increase in corporate defaults and credit spreads; and a massive
process of re-intermediation into the banking system of
activities that were until now altogether securitized." (Nouriel
Roubini's Global EconoMonitor)
"A generalized meltdown of the financial
system".
Looks like Chicken Little might have
gotten it right this time; "The sky IS falling."
