ECB voices ‘high concern’ over liquidity scheme
By Paul J Davies and Norma Cohen in London and Anousha Sakoui in Vienna
Thursday May 15 2008 17:45
The European Central Bank on Thursday voiced its “high concern” at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.
Yves Mersch, a governing council member, said the ECB was now “looking very hard at whether there is not a specific deterioration of collateral” which the central bank is accepting in return for funds.
He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank.
Who are these people trying to kid? The very essence of all the emergency action at CBs, including the Federal Reserve, has been to provide a way for banks (and now others) getting sucked under by toxic assets backed by plummeting collateral to find cash to bail themselves out. The Fed has entirely rewritten the rules, including going outside of the banking community by rescuing Investment Brokerage Firms. At one time the Fed required AAA Treasuries as collateral, but now it will swap those AAA Treasuries from its reserves and accept in its place those tens of billions in mortgage backed toxic waste that has no marketplace. And CBs claim to be caught off guard? What a joke!
“The Federal Reserve as other central banks is obviously taking onto its balance sheet a lot of mortgages these days.” “Well, the creators of the Federal Reserve system would be rolling over in their graves if they knew the Federal Reserve is buying mortgages.”
– Former Federal Reserve Chariman Paul Volcker
Whether or not the creators of the Fed would be rolling over in their graves is debatable in our opinion. Like Andrew Jackson — we believe central bankers have always been dangerous, incompetent meddlers. We feel the Fed should never have been created — and and that it continues to prove itself as bungling as any other central planning committee. But we digress…. That said, the former chairman’s grave concern over the central bank taking on billions of not so hot private debt is quite valid.
Beyond the blatant example of the Fed’s $30 Billion bailout of Bear Stearns — we now see Senator Christopher Dodd proposing the creation of an FHA program to insure refinanced mortgages following partial forgiveness of the loans by lenders. OK, let’s think about this. In an environment where U.S. foreclosures have risen 65% over the past year — and private banks/lenders are preferring to seize homes rather than renegotiate with already defaulting borrowers — the Federal Government is going to step in with money it does not have (but will be all to happy to print) — to back already bad debt.
Also, earlier this month, the Fed agreed to accept securities backed by student loans pledged as collateral for Treasuries the central bank would in turn lend to Wall Street Investment Banks. Let’s analyze that deal. Investors had become far less willing to finance student loan debt at pre-existing prices — due to liquidity issues, the economy, and the fact that consumers (including students) are hurting — and are therefore higher credit risks. The cost to finance such loans would have to naturally go up. Wall Street investment banks (you know, the ones who paid themselves billions in record bonuses over the past year) were less willing to hold onto securities they owned backed by this type of debt. However, if they tried to sell it — they would sell it for a loss. No worry, the Fed would lend/swap them Treasuries for the riskier (and worth far less) student loan backed securities.
Effectively, you have the government, or quasi government institutions backing substandard debt with money it will have to print. That spells one thing — accelerating inflation — and the always accompanying confiscation of private savings. And we’re not talking the low single digit inflation figure the government “calculates” (and bases Social Security payment increases on). We’re talking about the inflation you see in the supermarket ($4 for a handful of blueberries anybody?) — and at the gas pump.
When we hear the Treasury Secretary, or the Chairman of the Fed talk tough on inflation and defending the Dollar — we just smile. When we hear political candidates blaming oil companies and “speculators” for rising prices — we smile again.
We think the next 3-5 years will be quite interesting.
Its always a small sidebar in these type of crisis: the banks too small for the big guys to care. Rather than being bailed out, they simply are absorbed at pennies on the dollar by the big boys whose hands are firmly in the till of the Fed.
Only three banks have failed year to date, but the third — ANB Financial, which controlled $2.1 billion in assets with $1.8 in deposits — much of it demand deposits like your checking account — is no small fry. Expect more as the recession really takes hold and payments hit the skids on the extreme overhang caused by massive easy-credit-caused dislocations. Seems the Feds expect more, as well:
“FDIC is planning to beef up its staff, including temporarily hiring up to 25 retired FDIC employees who worked in the agency’s more than 200-person division that handles failed banks. They will handle an anticipated increase in bank failures.”
Obviously the failure of Bear Stearns would have triggered cascading defaults given so many players were writing credit default swaps on securities that did not even exist, thus adding multiples to Bear’s actual debt market value — at least in terms of liabilities to those who were insuring the risk. You can imagine 12 months ago those writing these derivatives never would have dreamed Bear Stearns could go under, and you can be sure there premiums were well under priced vs. the risk, yet still considered easy money. Think there’s any coincidence that JP Morgan had been writing upwards of 45% of all credit default swaps in the market place and the fact that the Fed enabled them to keep Bear’s head above water? Imagine the liabilities that would have sucked JP Morgan down with the ship.
Again, some banks are small enough to fail. Tough luck. Others? Let the shell game continue.
You have to love Alan Greenspan. Today he’s quoted as having declared the worst over for the credit crisis during a speech in New York. Yet, at the same time he still thinks housing has a long way to go down, and will not be hitting bottom by year end. Well, which one is it going to be, Sir Alan? Given the implications of the latter, it certainly can’t be both! Perhaps that’s why Mr. Greenspan is requesting the press not cover his speech comments?
Longtime readers of VI know where we stand on the issue, but as of late your writers have been busy in our full time consulting business — the economy unfolding much as we predicted to many people we’ve talked to over the years has brought much interest as you can imagine. That aside, though, updates like this one will continue as our schedules allow.
Currently we’re taking the approach that we’re now amid a sort of eye of the hurricane situation, with one glaring exception. The eye of the storm is welcome to those enduring the prior chaos, but even though it might appear that the worst is past, there are still plenty of signs that all is not normal. Usually the eye represents the half-way point for a hurricane, but in our economic case, our estimation is that we are fortunate to be about 1/3 of the way through. Just consider the signs:
Does this sound like a real “all clear” signal to you? We’ve been hearing the calls of “the bottom” since the implosion hit last summer with Bear Stearns at the epicenter. These calls keep coming from the people who failed to see any of this mess arriving, and are the same ones who’ve continually misdiagnosed problems since then.
Don’t count on these same rascals to correctly call anything, especially Honest Al Greenspan who is doing whatever he can to salvage his eroding reputation as the man who tamed inflation and the business cycle. In reality, he merely compounded the distortions on both ends.
Recessions are like earthquakes — better to have the pressure relieved in many smaller releases. In the real world, you rarely feel earthquakes since most are so mild. Consider that the natural business cycle, where you have normal ups and downs. Only problem is the meddling policy maker find those not politically tenable while the banker finds their restraint terribly inconvenient, so in cahoots they inflate and create boom / bust cycles. Everyone loves the highs these injections give the economic addict, but nobody likes the abyss of withdrawal. And the abyss is deep.
Instead, Fed policy under Greenspan and now Bernanke is all about holding off any release of tension as long as possible. In an attempt to sustain the unsustainable (overly inflated asset prices backing the entire Wall Street system) they’ll go back to the old inflationary tricks and rewrite the rules for the Fed without any Congressional authority. The tension only compounds, and eventually the release will be much uglier thanks to their meddling.
We expect serious consumer pull back as more jobs are hacked in the face of tight credit. We also expect stagflation — the Fed, its Wall Street backers, and the Dependent politicians in D.C. will do what they can to punt this problem into some future administration’s lap. Problem is, they appear to have finally run out of rope.
Hence, as the eye of the storm passes, get ready for the worst 2/3′rds of it.
“I think we were really on the verge of a financial collapse of unbelievable proportions that we haven’t seen since the 1930’s.”
– Former U.S. Treasury Secretary Paul O’Neill describing the Bear Stearns bailout in an April 16, 2008 interview on Bloomberg
Read that quote again by Paul O’Neill – because, yep folks, that’s really where things stand. Our financial system effectively patched together by an inflationary, money printing band-aid. And, as the real estate markets in England, along with those in Spain, Ireland, et al. continue to melt down, we maintain our belief that the whole fiasco is far from over. (Our regular readers know we said the same when conventional pundits said the worst was over in 2007).
The interesting thing about economics is that people have been conditioned to believe in the charade that it is a mysterious, complex, science – and to be successful at understanding it, explaining it to the great unwashed, and at running large portfolios – one must be a superior mathematician educated at the most prestigious of universities. As we watch the same geniuses educated at said universities – some of whom had supposedly developed mathematical models which had eradicated risk – continue to drive hedge funds (and at least one major Wall Street brokerage firm) valued in the $ billions straight over the cliff– we say – “oh really?”
We instead choose to take Harry Truman’s quote — “There is nothing new in the world but the history you do not know”– to heart when we look at economics. History is in fact the study of human behavior – of what has worked, and what has failed. To ignore historical facts one must be either arrogant, a fool – or an arrogant fool. So, as Sir Alan Greenspan and his knights at the Fed Round Table repeatedly cut rates earlier this decade – we warned that the unfolding scenario looked a whole lot like Japan in the 1980’s and 90’s! A Stock market bubble, followed by a stock market crash – and subsequent economic pain. Then came massive interest rate cuts to supposedly “stimulate” – which instead caused a real estate bubble – followed by a real estate collapse, and a severe, prolonged recession.
Sound familiar?
What next? We see the bailouts continuing — simply because the alternative is the severe and necessary corrective pain to clean out the mess and get prices of all things back in line. And what politician, Wall Street banker, investor, or voter wants to deal with that reality? And bailouts spell inflation. Not the fudged low-ball inflation that’s used to calculate Social Security payment increases or “official” economic growth. We’re talking about real inflation. The rapidly rising kind you are seeing at the supermarket and the gas pump on a daily basis. As these inflationary bailouts continue – look for prices of all things tangible to increase dramatically.
Commodities bubble? We think not – because bubbles require excessive stockpiles/inventory/supply – and we don’t see that at all – in anything. And we see inflationary (money printing/bailout) policies accelerating.
Oil at $125 in the near future anyone? $5 Dollar gas at the end of the year? Food prices continuing through the roof? It would not surprise us at all.
And so the consequences are continuing to unfold, the market is at a loss as to what the real prices of certain assets are in relationship to one another. Meanwhile, with all the money flooding into overpriced financial assets, it’d appear that resource development was largely forgotten outside of politics catering to the environmental movement, which has merely created vast supply shortages in the face of rising demand. Especially note the curbs on exports of commodities and the rationing.
Rogers speaks the truth. Recall, Rogers was the original thinker behind the Quantum Fund (which made George Soros) back in the 1970s. He was right then, and he’s right now. Of course, he’ll be ignored and the free market will continue to get blamed for the problems created by the price fixers and central planners, and the latter group will promise more solutions to those problems that will only make the situation worse.
How do you navigate this situation? Why, with vigilance and proper planning, of course! Think it through.
When your dealing with an addict, you don’t trust their word when they say they’re going in the right direction when they won’t even admit they have an addiction problem.
That’s the problem with our financial system. Consumers are addicted to credit and money supply expansion policies. Wall Street enjoys the comfy ability to profit from deals financed with money minted out of thin air. The banking system enjoys being able to profit from loaning and deal-making with the money you think is there in the bank, ready for withdrawal when you want it. (No doubt, those banks really love their 10% fractional reserve requirement and having the Fed a the ready bail them out with fresh cash when the de-facto embezzlement is revealed when depositors actually decide to withdraw their supposedly liquid money all at once, as amid bubble-bursting environments they’re wont to do.) And, of course, Washington D.C. loves having a secretive, privately held central bank finance its shortfalls. What politician won’t practically sell the sun, moon, and stars to win an election, to hell with the future generations that will suffer when the tab for said free lunch comes due? Just print the difference, and let some other sucker figure it out down the road.
And that’s the problem. Down the road is arriving leaving us with no good options. And, so, above we have Glen Beck and Ron Paul soberly discussing the issue the other primary candidates pretend doesn’t exist because the only realistic solutions are too controversial to assure victory among the masses of voters, who most assuredly have made it clear they much prefer having their ears anoint with yet even more impossible to promises delivered in language soaked in honey. As such, Ron Paul and Glen beck will be dismissed as they are always, although we’ll admit it is a good sign that at least Glen Beck is catching on.
Nonetheless, the addicts out there– voters included — consider Ron Paul to be among the Tinfoil Hat Wearing Crowd (a title which yours truly has been labeled a few times). So the system continues to conjure up more ways of getting our addict more of the junk he craves, and the Fed — the dealer who has steadily and stealthily pilfered over 95% of the dollars value since its creation in 1913 — stands ready to give the addict his fix.
The addict, no doubt, loves the party — the good times of the high. But even more desperately, the addict wants to avoid the pain of cleaning up his act and enduring the awful reality that is withdrawal. Addicts will sell themselves into prostitution, and worse, to avoid cleaning up. And so, too, our actors in our economy resist reality — choosing instead to prop up asset prices based in fiction — houses, condos, irrationally priced securities –, and systems rooted in fleecing dollar holders and those on fixed incomes for the benefit of the few. Addiction is a bitch.
But we all know, feeding an addiction is not the path to restoring health, and unfortunately our addicted economy is long in the tooth in juicing itself up into artificial cycle-highs and juicing up more in warding off cycle-lows. No doubt our addict economy has swooned a few times; recently it almost fell over during the 2000-2002 fiasco, but for the good fortune of Alan Greenspan standing on the corner telling everyone that he had the good stuff that would make everything OK.
And so the next bubble crashes — a big one — rife with dislocations so massive one wonders if this time the addict will be forced to face reality… or if he’ll make it through another bubble with another fix. If he gets back up to his old ways, I’d not be betting on his good fortune lasting long.
What of the Fed? Congress? The people? The cry for another fix has been heard loud and clear. Its just a waiting game now.
Leave it to the British to hit the economy with such a bold declaration. Granted, in the United States all policy makers are very fond of saying something to the effect that this situation and the subsequent policy reactions are the most drastic since World War II. World War II? We think this is a polite way of saying “since the Great Depression,” while hoping folks won’t go all panicky on the situation as they load their bunkers and prepare for the worst.
Granted, contemplating the concept of “bunker” has been more or less what Vigilant Investor has been doing since April 2005 — which by the way, today marks our 3rd anniversary since going full bore on the internet. Prior to that we published to our client base only as the Ernharth Wealth Report discussing the emerging Great Credit Bubble with issues dating back to 2001.
But what of this Great Depression talk the British press had jumped on? Let’s take a look.
We knew things were bad on Wall Street, but on Main Street it may be worse. Startling official statistics show that as a new economic recession stalks the United States, a record number of Americans will shortly be depending on food stamps just to feed themselves and their families.
Well… Of course this is an issue, but what’s new about food stamps? So, it would look as if this alarming headline really does not address the issue of Depresssion and Unemployment in a more relevant fashion other than to lament for the poor … so we will address this issue briefly. Is another Great Depression a reality? Let’s start from where this article begins: with the unemployed — a figure that hit 25% during the 1930s.
America has slowly been subsidizing an underclass for decades. One wouldn’t know this is happening using the official unemployment figures because, as we’ve reported over the years, the unemployment stats published by the government have been so politicized that the chronically “not working” are simply removed from the official figures, categorized instead as discouraged workers. Those folks are not unemployed, since unemployed, you see, implies someone is actually looking for a job. So, if you’re not looking for a job, you can’t be unemployed. So you must be something else. Discouraged perhaps? Discouraged it is!
The last real figures calculated using older methods like those used during the depression put U.S. unemployment (meaning those capable of working and not) closer to 13% vs. the official number running dramatically lower. And that does not account for the only employer with long term growth strength in the U.S. — the government, which has also done a slight of hand by hiring otherwise unemployed folks in various welfare to work schemes — reminiscent in its own way to FDR’s give a man any job routine.
Regulators “are playing with fire,” said Allan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh. “With good luck, none of these liabilities will come due. We can’t expect that good luck, and we haven’t had it.”
– Bloomberg (March 26, 2008)
We ask — who in their right mind would lend out their own money backed by such risky collateral? Who today would buy mortgage backed bonds with their own money?
Ah, there lies the rub! It’s not their money which backs these shenanigans – it yours!
We’ve continually warned about the bailout addicted U.S. Another voice of clarity and reason all along has been Bill Fleckenstein. As usual, he nails it in his latest commentary, “Catering to the Bailout Nation.” BTW, Bill’s recently released book Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve – is definitely worth a read! We wonder — has anyone ever been un-knighted? Can they do that?
Any reasonable person knows that bailouts beget more (and larger) bailouts. Like a drunk having another drink, it’s just going to make the hangover (and resulting inflation) even worse.
Also, ask yourself this one – why are big Wall Street banks getting bailed out (with taxpayer money) – when the 5 largest recently paid themselves 39 $Billion in bonuses?
Think long and hard about the answer to that one – because you are paying for it – in overt taxes, and the great hidden tax – accelerating real inflation.
With today’s 75 basis point rate cut – we see continued evidence as to whom the Fed really serves. As we have long said, it’s not you and I – it’s the Big Wall Street Banks. The “Big Rip-Off” of your savings continues. Jon Markman gets right down to it…
That was on March 11, just a few days go when Bear Stearns was trading on the close at $62.97… Cramer has since clarified he wasn’t talking about the stock, but rather those with money in the bank, so to speak. But this wasn’t the first time:
“This is a liquidity issue, not a credit issue… If you panic out of Goldman, Bear Stearns, and Lehman right now… you’re an idiot!”
That’s from Mad Money on June 22, 2007 when Goldman closed at 222.40, Bear at 143.75, and Lehman at 76.62. Earlier this January Bear traded up around $136.
“Nobody saw this coming.”
That’s a refrain we keep hearing from the Wall Street apologist crowd, who are just as quick to blame investor’s irrational fears for what’s transpiring. Regular readers here at Vigilant Investor, of course, knew full well the storm was coming and that it would take down housing and mortgage markets, and bleed into the rest of the credit markets. Our readers also knew things were only in their infancy last summer when many a popular pundit given air time suggested the worst had already passed. Our readers also knew to discount many of the same financial punditocracy who proclaimed the bottom was reached in the Fall, and then earlier this Winter. You also know we think this still has a very long way to go.Well, with Cramer’s thoughts above, we though this was a primary example of sloppy thinking. Actually, the problem with the thinking is not that it is necessarily sloppy, but that it is clouded by the illusion of knowledge. Too many in contemporary finance have come to believe in the fantasy of a false paradigm; a paradigm whose foundations are now exposed as having been built on sand.That’s not to say that many of the rules that governed this paradigm didn’t have some relevancy, but they were still, nonetheless, subject to the general theory of relativity. E=MC
If you’ve been schooled in layman’s relativity, you’ve come to understand Albert Einstein’s initial, rudimentary point that what someone sees and experiences as a passenger on a train is far different from what another person experiences standing next to the track as that same train passes by. A passenger tossing a ball inside the train experiences a ball that goes up and down into his hand, while the person alongside the track watches as person and ball blaze past at 50 mph. Meanwhile, the person in the train sees the hillside across the valley slowly move from one side of his field of vision to the other, yet for the stationary track side viewer, the hillside is set firmly where it is.
An analogy can be made to what’s happened to the many folks on Wall Street and around the world who are currently suffering from the effects of The Great Credit Bubble Collapse of 2007-2012. As author Daniel Boorstin observed in his book The Discoverers, the greatest obstacle to realizing the earth was round and the oceans lead to other continents was not ignorance, it was the illusion of knowledge. From the perspective of those knee deep in the now collapsing world of contemporary finance, from their seat in the train, so to speak, all their rules of their environment worked perfectly and for many years. There sense of the rules of finance were as believable to them as the rules of geocentricism was to the most learned Kings, courts and Clergy prior to Copernicus. Today’s false premise crafted rules that believed players could keep building up asset values using more and more expanded credit, and the economy could tolerate more debt and money inflation than many critics ever imagined possible. When a business cycle would run into problems, invariably the Fed could pull the nose up on the economy and get things going again without too much pain, and a good solid injection of more debt and liquidity. Sometimes there were blowups, but the Fed always stepped up to the rescue.
Meanwhile, major players from investment banking to hedge funds and private equity firms all mastered riding these business cycles, and it was for a moment as if risk had entirely been removed from the market place. The laws of the paradigm proved to them anything was possible.
Well, at least from the perspective relative to passengers riding the wild train of contemporary finance. The problem is, the set of rules governing their relativity were subservient to the greater laws of economic gravity. Indeed, a nation cannot consume itself to riches, nor can it indebt itself unproductively to permanent economic growth. Yet it was on that foundation that Greenspan, Bernanke and most of Wall Street and Washington D.C. have operated. That’s a recipe for disaster, and it should come as no surprise that any structure built on such a flimsy foundation would be a house of cards ready to drop.
Seems like Sir Al can’t try hard enough to absolve himself from the monster he created with the tools available via The Creature From Jekyll Island. Here are our thoughts on Honest Al’s latest comments.
We will never have a perfect model of risk
(By Alan ‘Master of obvious” Greenspan)
The current financial crisis in the US is likely to be judged in retrospect as the most wrenching since the end of the second world war. It will end eventually when home prices stabilise and with them the value of equity in homes supporting troubled mortgage securities.
Since World War II? Try since the Great Depression. This situation is as if 1930 met 1973 and used a fertility clinic to produce sextuplets.
Home price stabilisation will restore much-needed clarity to the marketplace because losses will be realised rather than prospective.
It will, however, not restore clarity to Sir Al’s amorphous use of the English language to convey something without really saying anything. Look, the pricing mechanism has been so badly distorted — and not just in housing — it’ll take a substantial cleansing to restore any sense of rational order. The Fed’s meddling will do nothing but continue to subsidize the fantasy that is “price” across many asset classes, housing included. Al should know this.
The major source of contagion will be removed.
How so? By propping up prices artificially as is being done as we speak?
Financial institutions will then recapitalise or go out of business.
With whose wealth? With wealth confiscated from dollar holders via every more inflationary credit expansion!
Trust in the solvency of remaining counterparties will be gradually restored and issuance of loans and securities will slowly return to normal. Although inventories of vacant single-family homes - those belonging to builders and investors - have recently peaked, until liquidation of these inventories proceeds in earnest, the level at which home prices will stabilise remains problematic.
Trust may be restored, but that’s badly placed trust if it is through yet another bailout. As for home prices, any price stabilization that comes from bailout is merely fantasy stabilization. With the Fed fixing the price of money, we’ll — expect as many dislocations as you would from some arbitrary panel fixing the price of Corn, gas, or anything else. But this is at the heart of the central planning meddlers in the Fed and Treasury (and their many supporters), who trust price fixing well ahead of free market allocation of scarce resources, some out of misguided economic beliefs, but as many if not more out of being directly enriched by being able to tap into the Fed printing press and create massive personal profits form the privileged.
The American housing bubble peaked in early 2006, followed by an abrupt and rapid retreat over the past two years. Since summer 2006, hundreds of thousands of homeowners, many forced by foreclosure, have moved out of single-family homes into rental housing, creating an excess of approximately 600,000 vacant, largely investor-owned single-family units for sale. Homebuilders caught by the market’s rapid contraction have involuntarily added an additional 200,000 newly built homes to the “empty-house-for-sale” market.
Uhh… Al? How nice of you to comment from the sidelines as if you weren’t the head cheerleader behind this mess? Homeowners were lured in by none other than You, pal. You told everyone that housing was not in a bubble, and denied being able to rationally indentify one even if it was beating you over the head with a lead pipe. You were the one that suggested ARMs were a good way for consumers to go. You were the one encouraging everyone to help the economy by borrowing and consuming more and more.
Home prices have been receding rapidly under the weight of this inventory overhang.
Created by the artificial oversupply of easy mortgage credit, created by YOUR POLICIES!
Single-family housing starts have declined by 60 per cent since early 2006, but have only recently fallen below single-family home demand.
