When Lehman Bros flopped last year, markets went into freefall. A sharp correction turned into a full-blown panic. The bubble burst and trillions of dollars in credit vanished in a flash. Trading in exotic debt-instruments stopped overnight. A global sell-off ensued. Markets crashed. For a while, it looked like the whole system might collapse.

The Fed’s emergency intervention pulled the system back from the brink, but the economy is still wracked with deflation. Billions in toxic waste now clog the Fed’s balance sheet. The dollar has fallen like a stone.

When the financial system blows up and credit is sucked down a capital-hole, the economy goes into a downward spiral. Businesses slash inventory and lay off workers, workers have to cut back on spending and credit. That creates less demand for products, which leads to more lay offs. This is the vicious circle policymakers try to avoid. That’s why Fed chair Ben Bernanke wheeled out the heavy artillery and launched the most aggressive central bank intervention in history.

The Fed dropped rates to zero, but its Quantitative Easing (QE) program (which monetizes the debt) actually pushes rates even lower to roughly negative 2 percent.

Bernanke has underwritten every sector of the financial system with government guarantees. He has provided full-value loans for dodgy collateral which is worth only a fraction of its original value. The market can no longer operate without the Fed. The Fed IS the market, which is why it is foolish to talk about a “recovery”. The idea of recovery implies a free-standing system based on supply and demand. But, for now, the government provides the demand, which is why there is no market and no recovery. Analysts at Goldman Sachs sum it up like this:

How much of the rebound in real GDP was due to the fiscal stimulus, and where do we stand in terms of the effects of stimulus thus far? Although precise answers are impossible at this juncture, several aspects of the report are consistent with our estimates that the fiscal package enacted in mid-February as the American Recovery and Reinvestment Act (ARRA) would have accounted for virtually all of the growth reported for the third quarter.

Positive growth is an illusion created by government spending. The economy is still flat on its back. Consumer spending and credit are in sharp decline. Unemployment is steadily rising (although at a slower pace) and wages are flatlining with a chance of falling for the first time in 30 years. Deflationary pressures are building. The talk of a “jobless recovery” is intentionally misleading. Jobs ARE recovery; therefore a jobless recovery merely points to asset-inflation brought on by erratic monetary policy. Surging stocks shouldn’t be confused with a genuine recovery.

The Fed faces stiff headwinds ahead. Low interest rates can have unintended consequences. The “cheapness” of the greenback has made the dollar the funding currency for the carry trade. Investors are borrowing low cost dollars and using them to purchase higher interest assets elsewhere. The process, which is rapidly escalating, is fraught with peril as economist Nouriel Roubini points out in an article in the Financial Times:

Since March there has been a massive rally in all sorts of risky assets… and an even bigger rally in emerging market asset classes (their stocks, bonds and currencies). At the same time, the dollar has weakened sharply, while government bond yields have gently increased but stayed low and stable…

But while the US and global economy have begun a modest recovery, asset prices have gone through the roof since March in a major and synchronized rally….Risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals.

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fueling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates…

Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing…

…This policy feeds the global asset bubble it is also feeding a new US asset bubble…. The reckless US policy that is feeding these carry trades is forcing other countries to follow its easy monetary policy….This is keeping short-term rates lower than is desirable…. So the perfectly correlated bubble across all global asset classes gets bigger by the day.

But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate… the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.¹

Everyone who watches the market has noticed the inverse correlation of stocks to the dollar. When the dollar fades, stocks soar. And when the dollar strengthens, stocks plunge. Eventually, the dollar will reverse-course and stage a comeback, probably when Bernanke stops his printing operations. That will trigger the next severe correction which will burst bubbles across all asset classes.

Bernanke’s success in reflating sagging asset prices has depended entirely on interest rate manipulation and liquidity injections. There’s been no effort to patch household balance sheets, increase production, or strengthen overall demand. It’s a clever trick by a master illusionist, but it has its costs. When the dollar rallies, markets will crash. And Bernanke will mainly be responsible.

1. Nouriel Roubini, “The Mother of all Carry Trades Faces an Inevitable Bust,” Financial Times.

The Senate is pressing ahead with the bill despite overwhelming disapproval from liberal and conservative economists. Their main objection? It’s a waste of money. The Brookings Institute estimates that the $8,000 credit costs taxpayers $43,000 per home. This is based on the fact that 85% of the nearly 2 million buyers were planning to buy a home anyway. The new add-ons to the bill mean that its final costs will be much greater than originally anticipated.

The senate bill is nothing but a $6,500 bribe to keep people in their homes and out of foreclosure. It’s another giveaway to the banks so they don’t have to face the mountain of debt they generated through fraudulent loans. The banks aren’t satisfied with merely blowing up the financial system and extracting trillions of dollars from taxpayers to fix the mess they left behind. Now they want to ensure that they’re a constant drain on public resources, by diverting dollars earmarked for healthcare or state aid into broken institutions run by high-stakes gamblers. The Congress has played a critical role in this fiasco.

The Senate has also shrugged off the many reports of fraud related to the home-buyer credit. Here’s an excerpt from the Wall Street Journal which summarizes hundreds of similar stories:

News of the latest taxpayer-funded mortgage scam has traveled fast. The Treasury’s inspector general for tax administration, J. Russell George, recently told Congress that at least 19,000 filers hadn’t purchased a home when they claimed the credit. For another 74,000 filers, claiming a total of $500 million in credits, evidence suggests that they weren’t first-time buyers.

Among those claiming bogus credits, at least some of them were definitely first-timers. The credit has already been claimed by 500 people under the age of 18, including a four-year-old. This pre-K housing whiz likely bought because mom and dad make too much to qualify for the full credit…

As a “refundable” tax credit, it guarantees the claimants will get cash back even if they paid no taxes. A lack of documentation requirements also makes this program a slow pitch in the middle of the strike zone for scammers. The Internal Revenue Service and the Justice Department are pursuing more than 100 criminal investigations related to the credit, and the IRS is reportedly trying to audit almost everyone who claims it this year.¹

Does it bother senators that the public is being plucked like a Thanksgiving turkey, once again?

Everything that has been done to prop up the ailing housing market, has really been aimed at helping the banks. The Fed has launched the biggest government intervention in history– purchasing more than $900 billion in mortgage-backed securities, $200 billion in agency debt, and another $300 billion in long-term US Treasuries–all to stabilize a market which was sabotaged by the Fed’s low interest rates and the banks abyssal lending standards. Private label “securitized” mortgages have defaulted at 5-times the rate of conventional loans, clear proof of fraud.

The Fed’s capital injections will eventually add $2 trillion to the aggregate value of the residential real estate market. The Fed is doing its best to prevent the market from clearing by keeping home prices artificially high. That’s the only way to avoid more bank failures.

The Fed’s intervention is a sign of desperation. In the long-run, the action is unlikely to have any bearing on prices which will be determined by incomes and supply. Housing inventory is still unusually high, which is putting downward pressure on prices. Distress sales (short sales, foreclosures etc) represent 45 percent of all home sales, which reduces the number of creditworthy buyers for organic sales.

So, what has the Fed’s multi-trillion dollar intervention achieved aside from creating a fake market with fake interest rates, fake financing, fake down-payment ($8,000 first-time home buyer giveaway) and fake media coverage of a fake rebound. Not much, really. The Wall Street Journal’s James Hagerty sums it up like this:

Uncle Sam’s interventions in the housing market have pushed home prices 5% higher on a national average than they would have been otherwise, Goldman Sachs estimates in a report released late Friday…

But these artificial props won’t last forever and may have created a false bottom in the market.

“The risk of renewed home-price declines remains significant,” Goldman economist Alec Phillips writes in the report, “and our working assumption is a further 5% to 10% decline by mid-2010.”²

Over $1 trillion has been committed so far, and prices have budged a mere 5%. Does Fed chair Ben Bernanke really believe this is an affordable plan?

The Administration’s Making Home Affordable Modification Program (HAMP) will have only a marginal effect on the rate of foreclosures when the next wave of pay-option adjustable-rate mortgages and other oddball loans come due. And, when the loans reset, more banks will default pushing even more inventory onto the market at firesale prices. Foreclosures have exceeded 300,000 for the last 3 months and the inventory-backlog suggests the worst is still to come.

This is from Diana Golobay at housingwire.com:

Recent analysis by the Amherst Securities Group indicates the housing industry will not only worsen as a delayed pipeline of foreclosed loans begins to liquidate, but that the Administration’s Making Home Affordable Modification Program (HAMP) will have no lasting effect on keeping delinquent loans current…

Amherst estimates this “shadow inventory” at around 7m housing units, or 135% of a full year of existing home sales, compared with 1.27m units in this bucket in early 2005. The backlog is due to high transition rates, low cure rates and a longer timeline for loan liquidation — in other words, loans continue to transition into the delinquency/foreclosure pipeline at a rapid pace, but are moving out at a very slow pace.

The loans, however, are “destined to liquidate” and will impact the signs of recovery seen in recent months by pulling down house prices through distressed sales.³

So, what can Bernanke do to head-off a bigger meltdown in housing?

The Fed revealed its long-term strategy in the minutes of its September 22-23 FOMC meeting. Here’s an except from the Fed’s statement:

The Committee agreed that it would continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. Members discussed the importance of maintaining flexibility to expand the asset purchase programs should the economic outlook deteriorate or to scale back the programs should economic and financial conditions improve more than anticipated.

In other words, the Fed is planning to continue its quantitative easing (QE) program (monetisation) which pumps liquidity into the system and puts more downward pressure on the dollar. Bernanke is trying to inflate-away the problems in housing, but with little success. In fact, according to Robert Shiller, who created the index for measuring house prices in 20 major cities, the Fed may have generated another bubble. This is from the UK Telegraph:

The S&P Case-Shiller index… showed that house prices were up 1 percent from the previous month, following a 1.2 percent increase in July. However, August’s prices were still down 11.3 percent year-on-year, highlighting the continued problems in the market as a whole. Professor Shiller, who is credited with calling both the late 1990’s tech market bubble and the bubble that led to the US property market crash three years ago, pointed to price increases in areas including San Francisco and Minneapolis, which have seen double-digit gains in the last four months. He said that if these rises are viewed on an annualised basis they could be seen as “bubble territory.’⁴

Housing prices will continue to tumble through 2010 no matter what the Fed does. In fact, on Wednesday the Commerce Dept reported that sales of new one-family houses in September dropped to a rate of 402,000, down 3.8 percent from August. That’s 7.8 percent below 2008, well below economists worst predictions. The news sent stocks plummeting.

The sense that the economy is returning to normal, is an illusion nurtured by the financial media. This week’s dismal consumer confidence data, shows that the public “isn’t buying it.” And, neither are investors, who continue to avoid equities despite a seven-month, 68 percent rally in global stocks. According to Bloomberg, “Almost 40 percent of investors and analysts in the latest quarterly survey… say they are still hunkering down. U.S. investors are even more cautious, with more than 50 percent saying they are in a defensive crouch.” The mood is grim. The public has lost faith in the media, in the Fed, and in public institutions. The “cheery predictions” are no longer having any effect. No doubt, this will make it even harder to stabilize the teetering housing market.

1. ”First Time Fraudsters,” Wall Street Journal
2. James Hagerty, “Uncle Sam Adds 5% to Prices of Homes, Goldman Says,” Wall Street Journal
3. Diana Golobay, “Amherst Sees 7m Foreclosures Poised to Distress House Prices,” housingwire.com
4. UK Telegraph

Michael Yates: Corporate America began to wage what turned out to be a one-sided war against working people in the mid-to late-1970s, when it became apparent that the post-World War Two “Golden Age” of U.S. capitalism was over. As profit rates fell, businesses began to develop a strategy for restoring them. This strategy had many prongs, and one of them was ideological, that is, a struggle for “hearts and minds,” to use a military term now being applied to Afghanistan. The presumed failure of Keynesian economics, marked by the simultaneous existence of escalating inflation and unemployment, gave the ideological struggle its foundation. Maybe there had been too many restrictions placed on the market, and these restrictions (minimum wages, health and safety regulations, laws facilitating union organizing in labor markets; public assistance in the form of money grants, housing subsidies, and the like; restrictions on the flow of money internationally) had led to results opposite those that liberal Keynesians had thought most likely. If these complex arguments could be tied to simple cliches, like “get the government off our backs,” “the unions have gotten too powerful” (with always a hint that they are too radical thrown into the argument), and “welfare queens” (with that always popular whiff of racism), they could provide ideological cover for what was really a matter of corporate economics, namely the making of money.

This ideological attack bore fruit quickly. President Carter appointed Paul Volcker to chair the Federal Reserve Board of Governors, and Volcker, under the guise of fighting inflation, immediately began to snuff the life out of working class communities by forcing interest rates up to nearly 20 percent. Today, Volcker is treated like a hero by Democrats and above reproach (though ignored by President Obama’s more right-wing economic advisors), which shows just how far to the right economic discourse has moved. What Carter began, Reagan completed, firing the Air Traffic Controllers and putting the nail in labor’s coffin. Behind the scenes in all of this and growing in strength for the next twenty years (funded by wealthy business leaders) or so were the right-wing think tanks you mention. Just as retired generals go to work for military contractors and defeated politicians become lobbyists, government economic advisors get jobs at Heritage or the American Enterprise Institute or the Cato Institute. The staffs of these ideological centers churn out endless position papers and studies, which find their way into our newspapers and the offices of our congresspersons. A gigantic network of professors, journalists, politicians, lobbyists, and, today, a television network (Fox) bombard us with right-wing propaganda. That all of this has been successful is seen by the fact that the shibboleths of neoliberalism—such as the needs for privatization of public entities, the free reign of markets, the obviousness of the success of welfare reform, the evils of raising the minimum wage—are all commonplaces today.

While the public now knows that something is rotten, I am not sure that neoliberal ideas are so under attack that they will lose their sway. I think that the tenacity of these ideas owes something to the lack of an ideological alternative, which, in turn, is due to the abject failure of organized labor to provide one. For example, we need universal health care. Labor, however, has not consistently argued in favor of this or supported it at all. Now Congress is poised to enact healthcare legislation that might well be worse than the profit-driven system we have all come to hate. Labor should refuse to support this legislation, but I doubt it will. Then, when the new healthcare plans fail to deliver the goods, the right-wing will be lying in wait, ready to pounce and say, “See, we told you so. The government always makes things worse.” In other words, until there is a radical ideology to replace right-wing thinking, the latter is unlikely to lose its drawing power.

Fred Magdoff: Although these institutions were very successful, along with a number of other forces, in shaping public attitudes toward the economy, the reality of the current severe economic conditions are causing many, including some economists, to rethink their views of how “efficiently” markets function in the real world (as opposed to their ideological make-believe world) and that some different approaches may be needed. People seem to understand that the “big players” played a major role in the crisis, but most of the anger has been placed on the outrageous salaries of the top echelon. Of course, this is just “chump change” compared to the massive amounts at that are transferred to the wealthy through the speculative casino that our economy has become.

　
MW: Socialism has a huge public relations problem. Wouldn’t you agree that socialism has been effectively discredited in the U.S. media and that, even now–with unemployment soaring at 10 percent and more than 300,000 foreclosures per month–the average American worker still believes in the virtues of capitalism? How do you explain this phenomenon?

Michael Yates: Part of my answer here can be seen in my response to your first question. Socialism has, indeed, been discredited here, partly due to its rejection by its natural supporter, namely the labor movement. The CIO expelled in the late 1940s and early 1950s the left-wing forces who built the great industrial unions. When it did this, it abandoned the worker-centered ideology that might have laid the basis for support here for at least the kind of social democracy we find in the Scandinavian nations. This left the ideological field to the enemies of social democracy and socialism. Of course, we cannot ignore the long and inglorious history of police-state repression of those persons and organizations that championed socialism. Our government has never hesitated to arrest, imprison, and even kill the enemies of capitalism. So it has been dangerous to be a radical here, though not so much today when radical ideas aren’t taken seriously and there are no powerful radical organizations left. Suppose that after the Second World War, the left in the labor movement had grown, and the left-led unions had continued to successfully organize workers and win good collective bargaining agreements. Suppose that they had built upon their impressive worker education programs, made inroads in the South, and fought hard against U.S. imperialism and the Cold War. We might have a much different political terrain on which to fight today.

Two other factors that must be considered in the attachment of the working class to capitalism are racism and imperialism. In the past, employers routinely pitted white workers against black, and one weapon they used was to associate black workers (and the civil rights movement) with communism (It was interesting to note in this connection the attempts to make Obama out to be a radical socialist). The claim that black union supporters were reds helped to solidify white support for capitalism. By the same token, anti-imperialist struggles in the poor nations of the world (often former colonies of the rich countries) were typically led by political radicals. These could be made out to be anti-American, and then those in the United States who allied themselves with these struggles could also be labeled anti-American, despite the fact that they might also be supportive of policies that would benefit working people. The schools and the media could be counted out not to try to set anyone straight on any of this.

Now, having said this, I must also say that to the extent that left forces in the United States identified themselves uncritically with the former Soviet Union and its extremely undemocratic political system, they sometimes played into the hands of those opposed to socialism. And I must also admit that socialist forces were, at their strongest, never powerful enough here to force their best ideals permanently into the consciousness of the working class majority. Finally, in the past, the success of capitalism in the United States allowed for some sharing of the wealth with workers, and this, too, made people less willing to entertain radical ideas.

Old and deeply ingrained ideas die hard, and unless there are forces at work to develop new ones and unless there is at least widespread experimentation with new ways to organize production and distribution, little is likely to change, even in the face of economic catastrophe, such as so may working men and women are facing right now. Quite the contrary, workers might be persuaded that actions detrimental to their long-term self-interest need to be taken, such as, for example, draconian measures against immigrants.

Fred Magdoff: There is no question that the term socialism has a public relations problem. But while it’s true that most people don’t fully understand the basic workings of the capitalist system nor what socialism is, there are indications that many people are ready to talk about alternatives—and that includes socialism. The positive public response to Michael Moore’s movie, Capitalism, is one indication. But a Rasmussen poll last spring found that only 58% of American’s say that capitalism is better than socialism. For adults under 30, 37% preferred capitalism and 33% preferred socialism. It’s not clear what the poll results really mean. But it does indicate that people are willing to hear about and talk about alternatives to capitalism.
　
MW: In a chapter titled “Neoliberlism” you focus on the disparity of wealth in the US today. Here’s an excerpt:

By 2006 the top 1 percent of households received close to a quarter of all income and the top 10 percent got 50 percent of the income pie. In 2006, the 400 richest Americans had a collective net wealth of $1.6 trillion, more than the combined wealth of the bottom 150 million people. This degree of income and wealth inequality was last seen just before the beginning of the Great Depression. (pg 50)

Let’s ignore the moral issue for now, and focus on the supply/demand question. Is it possible for an economy to produce sufficient demand when more and more of the wealth and income goes to the upper 5 or 10 percent of the population? (isn’t this proof that capitalism is inherently crisis-prone?)

Michael Yates: If a certain amount of output is produced, an equal amount of income is generated. So, conceptually, there could be enough demand to buy the output, no matter that the incomes generated are getting more unequally distributed. It certainly has been the case that the rich people now getting such a large share of the pie spend gobs of money. And rich foreigners spend a great deal of money in the United States as well. However, the rich also save a lot of money (the more they get, the more they save), and this money does not enter immediately into the spending flow. Working people, on the other hand, can be counted on, by virtue of the limited income that they command, to spend all of their income. Therefore, the more income the rich have, the more savings there will be, and, unless some way is found to convert all this saving into spending on newly-produced goods and services, the more likely it is that there will be a crisis caused by not enough spending (and its corollaries of unsold goods and services and unemployed labor). If we understand that growing inequality is the normal trajectory of capitalist economies, a trajectory only mitigated by the power of organized working people to win a bigger share of the pie for themselves and to compel the government to intervene in the marketplace on their behalf, then it is correct to say that capitalist economies are crisis-prone for this reason alone.

Growing inequality also creates other potential problems for the system. Sometimes it can generate a political crisis, a crisis of legitimacy so to speak. The rich exert tremendous political power, and this power grows as those at the top command a larger and larger share of a society’s income. To the rest of us, the game looks increasingly rigged, with us having little chance to improve our circumstances through individual efforts. More inequality also has harmful social and economic consequences that we don’t normally think of. Recent research has shown that if we compare two entities (two states in the United States, for example) with equal average incomes but different degrees of inequality, then the place with more unequal incomes will also have higher rates of infant mortality, arrest and imprisonment, school dropouts, low infant birth weights, and many other measures of social well-being. Growing inequality actually kills some of us, makes some of us sicker, and puts some of us in jail.

I want to add an important point. To say that capitalist economies are crisis-prone, because of a tendency toward income inequality or whatever other reason, is not the same as saying that these economies are on their deathbeds, no matter how severe a crisis may be. It is possible for an economy to exist in a crisis or a prolonged period of slow growth (stagnation) without it being ready to collapse. In the end, it is political struggle, that is, class struggle, that truly destabilizes an economy and generates conditions in which it is possible to imagine the birth of a new system.

Fred Magdoff: It is one of the many contradictions of the system. If ordinary folk are paid well they can buy a lot of stuff and help keep the system going. So from the point of view of the system as a whole, higher paid workers would help the economy. However, there is only one driving force for individual capitalists–and that’s to make as much money as possible. What might be better for the overall economy can be of no concern to the individual trying to maximize profits. For an analogy, let’s take a look at ocean fishing. Almost every fish species is being fished to the point at which the population crashes. It would make sense for all of the companies operating the large trawlers to cooperate and fish less in order to preserve the resource on which they depend. So what’s good for their long-term future is sacrificed as each individually tries to maximize their catch and therefore profits.

MW: Here’s another excerpt from the book: “In 2006, the financial sector employed about 6 percent of the workers but ‘produced’ 40 percent of the profits of all domestic firms.”(pg 56) A few paragraphs later you add that, “Making money without actually making something turned out to be the largest growth sector of the U.S. economy from the early 1980s to the present crisis.”

This seems to imply that as manufacturing and other parts of the “real” economy have become less lucrative, the trading of paper assets has become Wall Street’s new profit-center, the Golden Goose. What impact has the “financialization” of the economy had on ordinary working people?

Michael Yates: I think that an answer here has two parts. First, it was the neoliberal “revolution” begun in the 1970s that did immense harm to working people. For example, unionization rates began to fall dramatically in the 1980s, as Reagan began his “magic of the marketplace” assault on the working class. Real wages (the purchasing power of our paychecks) began to stagnate in the 1970s and are not much higher today than then. Relatively high-wage public employment began to endure a long period of privatization, which also damaged working class living standards. The move toward “free trade” did workers here no good, as manufacturing began to flee our shores for low-wage havens abroad. None of these things had to do with financialization per se.

Second, however, once the neoliberal attack on working class living standards took hold and incomes began to flow upward, those with a great deal more money began to look for ways to put this money to work. The corporations that they owned also had higher profits, and they did the same. The United States has always had a robust financial sector, though in the past, it was not the tail that wagged the dog as far as our system of production and distribution was concerned. Neoliberalism brought with it a deregulation of international movements of money and goods and services. [It is important to note that we see neoliberalism as a political response to capital’s quest for restored profits beginning in the mid-1970s when the post-Second World War two economic boom ended and the slow growth (stagnation) common to mature capitalist economies reasserted itself.] These, in turn, required a certain amount of financial innovation, to reduce, for example, the risks of fluctuations in currency exchange rates and sharp changes in political conditions that could threaten investments. From these innovations came still more, until finance began to take on a life of its own. And while neoliberalism and direct corporate actions inside workplaces did reduce costs and raise profits, they did not create nearly enough capital spending opportunities (investment) to absorb the growing individual savings and business profits. Finance of one kind or another then began to be seen as a place to dispose of surplus and make still more money. Leveraged buyouts, stock market speculations, real estate “investments,” all took off from the 1980s on, absorbing money that could not find enough opportunities in the real economy of production. As these things happened, financial “innovation” exploded, with all of the alphabet soup of financial instruments we describe in our book.

This explosion of finance proved detrimental to working people in a number of ways. Leveraged buyouts inevitably resulted in the hollowing out of what were often perfectly viable businesses. Companies were saddled with debt, assets were stripped and sold, and workers were furloughed by the tens of thousands. The inflation of asset values gave rise to the notion that it was the job of managers to increase the share price of their businesses—in any way possible. Businesses came to be thought of as mere collections of assets rather than entities that produced things. Asset inflation gave rise to asset speculation and the development of ever more complex financial instruments, all leading sooner or later to financial bubbles and the inevitable bursting of the bubbles. As we have seen, the bursting of financial bubbles has had tremendously negative impacts on working people: shuttered workplaces and unemployment to name but the primary ones. The last bubble, in real estate markets, was harmful to workers not only after it burst but also as it was developing. In the aftermath of the dot.com bubble, Alan Greenspan, former Chairman of the Fed Board of Governors, directed Fed policy to pressure interest rates down to very low levels. This helped to push loose money into real estate. As house prices began to rise, banks and brokers started to encourage working people to do two things: borrow money against the appreciated value of their homes and buy homes, either as first-time buyers or as purchasers of more expensive homes (after selling old ones). Working people were eager to do both because they saw houses as sources of cash to compensate for stagnating household incomes and as a form of wealth that could help secure them against the hazards of ill health, lost pensions, or college-age children needing money for school. Working class households began to take on large amounts of debt, making themselves more vulnerable, even as they thought they were making wise financial decisions. Ironically, those who saw their incomes rise so high because of neoliberalism were now, in effect, loaning money to those who didn’t fare so well. As banks accumulated mortgages, farsighted Wall Street swindlers saw golden opportunities to develop a slew of new financial instruments based upon the packaging and repackaging of mortgages into new and exotic instruments. Greenspan played their shill, arguing that they had uncovered the secret of hedging infallibly against risk. From here it was but a short step to the criminal schemes of Countrywide and a host of other financial institutions. The billions of dollars made were used not only to finance a new gilded age of revoltingly lavish consumption but to corral the most tractable politicians money could buy.

Fred Magdoff: Financialization of the economy created the possibilities for people to take on more and more debt—credit cards, new cars, 2nd mortgages, etc. It was the selling of a lifestyle way beyond people’s ability to pay for it plus the easy access of loans that created the bind that many people find themselves in today. In essence, it allowed people to live beyond their means. They were encouraged to take on debt as their house values seemed headed up forever, and the great rise in foreclosures and bankruptcies is the unfortunate result of the financialization of the economy. Also, those people who had retirement money in individual accounts or with pension systems and thought that they had become very wealthy, now found themselves with much less to rely upon.

MW: In the last couple of decades, consumer debt has skyrocketed, as you note, “doubling from 1975 to 2005, to 127 percent of disposable income.” (pg 60) Have we gone as far as we can without deleveraging and paying down debts? What happens to a credit-dependent economy when the consumer can no longer increase his/her debt-load? Is this just the beginning of a decades-long down-cycle?

Michael Yates: Certainly no entity—not a person, a family, a business, even a government— can take on rising levels of debt (relative to income) indefinitely. Sooner or later, the piper has to be paid. Working-class consumers took on large amounts of debt, to compensate in part for stagnating wages and incomes, and, it is important to note, to pay for health problems and other household traumas. This meant that the burden of the debt rose, since income wasn’t rising as fast as the debt, and also because the interest rates charged on credit cards and subprime mortgages were so high. We at Monthly Review have been decrying the rise of consumer debt for many years, and we said that the debt chickens would come home to roost sooner of later. I must say that I was surprised that debt could be broadened and deepened for so long. The ingenuity of creditors in extending loan periods and devising so many new forms of debt has to be admired for its audacity. Then, the ways in which these debts were packaged and sold so that more debt could be extended was truly breathtaking. Unfortunately, consumers ultimately couldn’t pay and all hell broke loose. Now, with so much unemployment, workers are truly strapped. They will not be borrowing so much or spending so much anytime soon. [One interesting recent development is that, as some households have defaulted on debts or simply stopped making payments, consumer spending has showed a bit of an upward tick!] So the question arises: what spending will fuel a sustained recovery? It won’t likely be consumer spending. Capital spending was stagnating to begin with and was the root cause of the crisis. There are no new “epoch-making” innovations on the horizon that would generate the amounts of investment that were brought forth by the automobile. U.S. exports seem a very unlikely demand support. That leaves the government. In a capitalist economy, especially one like the United States with its lack of a history of generally accepted public spending, it seems very unlikely that public spending will make up for shortfalls in aggregate demand. Already, there are widespread entreaties (and not just from the far right) urging the federal government to wind down in spending programs—well before, I might add, the economy has recovered. As we see it, the United States is, indeed, in for a long period of stagnation, a “down cycle” as you put it.

Fred Magdoff: This is one of the major constraints on the system. The economy is in a process that economists call “deleveraging,” which is just another way of referring to somehow getting rid of debt. Some are able to pay off what they owe, a few are able to renegotiate down some of their debt, many are losing their homes, and some are going bankrupt. Until this works its way out, and a lot of debt is shed one way or another, there will be a drag on the “consumer” portion of the purchases. This is particularly significant to the U.S. economy because it is so dependent on consumer purchases—in 2007, these absorbed approximately 70% of the goods and services produced.

MW: The ABCs of the Economic Crisis: What Working People Need to Know is as lucid and compelling summary of the financial crisis as any I have read. In the closing chapter you state that capitalism is undergoing a “crisis of legitimacy” and that “the system can never deliver what is needed for us to realize our capacities and enjoy our lives… That “instead of private gain” the purpose of society and the economy is “to serve the needs of people, by providing the necessities of life for all, without promoting excessive consumption (consumerism) while protecting earth’s life support systems.”

All of the things that which kept capitalism in check–progressive taxation, crucial regulations, and the power of unions–have either been reversed, repealed or greatly eroded. More and more people are beginning to see the greed which governs the system, and it scares them. But is the country really ready for structural change or will the vision of an economy which “serves the needs of its people” be dismissed as “pie-in-the-sky” Utopianism?

Michael Yates: Well, first thank you Mike for the kind words. They are much appreciated. Typically, the best we have been able to hope for from the public in the United States has been an amorphous populism; people are willing to say that the system is corrupt and that it is biased in favor of the rich. But proposals for change, much less a radical transformation of the economic system, are rare commodities. I think things would be different, however, if we had a real labor movement, one that was rooted in communities, broad in its composition, and not afraid to have principles and stand by them come hell or high water. This should be the lesson that progressives learned from the right-wing. The talking heads of Fox may seem insane to us, but they and their intellectual gurus almost never deviate from the set of reactionary principles with which they began to transform the “common sense” of the nation. We suggest at the end of our book that we ought to ask ourselves if a return to the pre-economic crisis status quo is what we want. In the best of times, there is plenty of unutilized labor, a degraded environment, poverty, dead-end jobs, and much more that is not so desirable. So we chose a number of alternative outcomes to what we have now that we think have mass appeal, from universal healthcare to basic food guarantees. However, as you say, these might well, and I think will cause people to react with a pie-in-the-sky indifference. What might make working men and women stand up and take notice would be for these goals to have a mass-based advocate, one that would make these goals matters of rigid principle and begin to fight for them through mass actions. We might think that the right-wing ideologues we see on television are insane. Yet, come hell or high water, they stick to their guns. Their political and economic adherents have wielded tremendous power for a long period of time, and even today when they seem to be losing their grip on the national “common sense,” they can still mobilize the faithful. The left needs to take a lesson from this. More particularly, the labor movement must take a firm and rigid stand on issues like national health care, food security, environmental degradation, full employment, good and cheap housing, U.S. war-making and imperialis, racism, and a host of others. Then it must educate members rigorously and constantly about such principles. Most importantly, it must begin to actively fight to achieve them, activating its millions of members and allies, wherever it can find them. It is through action, bold and unafraid, that people’s minds will get changed and a new “common sense” developed.

Having said this, I think it is clear that the labor movement, as currently constituted, is not up to the tasks at hand. Too many unions are moribund, stuck in the failed labor-management cooperation mind set of the past and run by people too old and infirm to do much of anything. So, not only will we have to have a worker-led opposition to the status quo, fighting to change it radically, but this opposition will have to be built on a new basis. There are some hopeful signs, such as the development of community-based worker centers, mainly in immigrant communities. These may be models for the labor movement of the future.

Fred Magdoff: Just getting what should be the most reasonable reforms through Congress is a major effort, which usually fails or is corrupted in the process. Look what’s happening with health care “reform.” Even if a “public option” is finally part of the bill, it will be a bill that helps some people, but is primarily a boon to the health care industry, which will get a lot of new revenue. It’s not a bill designed with the single purpose in mind: how can we supply medical care for everyone at reasonable cost. Rather it’s a bill designed with significant input from the for-profit sector that will end up supplying them with extra profits. It is clear that government-run systems (and there are a variety of ways to do this) are far cheaper and more efficient and can actually cover everyone. SO, it seems as though piecemeal reform is a) very difficult to obtain and b) can be reversed as the power of the wealthy increases. A system is needed that can break the power of the wealthy and create a real political and economic democracy in order to be able to meet the basic needs for all the people.

There is also a correlation between stock prices and the dollar which should be considered. As equities have soared, the dollar has plunged. That’s because investors have become less risk-adverse than they were after Lehman Bros. collapsed. Now they have resumed speculation. Still, the S&P 500 is up over 60 percent since March 9, (which prices in a full three year recovery) which is “too much too fast.” According to John Hussman, “90% of stocks (are) suspended above their 50- and 200-day moving averages for as sustained a period as we have now observed.” (Hussman Funds Weekly Market Comment) That suggests that stocks are wildly overbought and that the market will soon correct, perhaps, violently.

Also, there is no shortage of investors and central banks willing to buy US debt which supports the greenback. Consider this report in last week’s Bloomberg:

Investors can’t get enough Treasuries even as the U.S. budget deficit climbs beyond $1 trillion, the government sells a record amount of debt and the dollar declines to the weakest level since August 2008.

Foreign buyers increased their holdings for a fourth consecutive month in August, to an all-time high of $3.45 trillion, according to Treasury Department data released Oct. 16. U.S. demand is being spurred by a rising savings rate and concern the economic recovery may falter. Fixed-income funds have attracted 18 times more money than stock funds this year, according to data compiled by Morningstar Inc. and Bloomberg.

Long-term, it is likely to be tough-sledding for the dollar, as government spending increases and fiscal deficits keep piling up. But in the short-term, investors believe that deflation is the biggest problem facing the economy. The surge in US Treasuries proves that point.

The notion that the dollar will crash, has become an article of faith among doomsayers, Libertarians, survivalists, leftists and goldbugs. (I’m as guilty as anyone) But is the theory supported by the facts?

First of all, “crash” is an ambiguous term. I take it to mean a plunge in the value of the currency to a hyper-inflationary range. What we are seeing now, however, is the Fed managing the value of the dollar downward to increase exports and reduce the real value of household and financial sector debt. That is not a crash; it is a planned demolition with the intention of improving the US’s position vis-a-vis its main trading partners. It is a type of currency warfare which is making the dollar more competitive at the expense of people who save. It’s exactly what Bernanke wants.

All the Zimbabwe talk is pure nonsense.

The reserve currency system is inherently unfair and invites all kinds of abuses. It gives the United States greater access to credit and elevates the dollar above all the other currencies. The dollar should be dethroned as the de facto international currency so that there can be greater parity between the currencies.

Those who believe that a “dollar crash” will bring the government to its senses or change the system, are mistaken. It won’t happen. Real structural change requires political activism and a vision of a system that is more equitable then the one presently in place. There’s no substitute for hard work.

Ironically, the Fed’s original plan for the TALF would have involved a $20 billion loan from the Treasury levered 10 to 1 to provide up to $200 billion in funding support for applicants. In other words, the Fed was planning to borrow money, to lend to people (investment banks and hedge funds) who were borrowing money to lend to people who were borrowing money (consumer credit cards, mortgages, car loans etc). Read that sentence again to fully appreciate how utterly fouled up the credit system really is. The Fed and Treasury are like private equity hucksters overseeing an inherently corrupt and immoral system. Michael Moore is right.

Fortunately, Bernanke’s plan to rebuild securitization has no chance of succeeding. The system can’t be restored because it required conditions which no longer exist; a strong currency, mega-surplus capital, and credulous investors who were unaware of the implicit risks of illiquid assets. Today, the dollar is wobbly, money is tight, and the pool of dupes ready to be fleeced has been greatly reduced. The notion that Wall Street can better perform the tasks traditionally left to highly-regulated banks, has also been called into question and rightly so. Unfortunately, the largest banks in the country — which have transformed themselves into investment casinos — don’t have the ability to return to the more conservative model of long-term lending to qualified applicants. They are stuck in a post-Glass Steagall mold, incapable of turning a profit on conventional loans to consumers and businesses. There’s a glaring need for some opportunistic entrepreneur (Warren Buffet?) to step into the breach and create a bank where depositors feel comfortable leaving their life savings knowing their bank is at least a notch-or-two above a Monte Carlo roulette table.

Bernanke will not give up the hope of resuscitating securitization because the financial mandarins who employ the Fed chief see it as an exportable model which will give them greater control over the global financial system. This is not taken lightly by the powers behind the curtain. The beauty of securitization is its utter simplicity; it simply transfers the authority to generate credit (money) from highly-regulated banks to rogue players in the shadow banking system. By borrowing short to invest in dodgy long-term assets, fund managers and PE smarties are able to expand credit to unimaginable levels, skimming off fat bonuses and salaries for themselves while the monster bubble limps slowly towards earth.

This is the system that Bernanke is trying to electroshock back into consciousness, albeit with negligible results. The Fed is essentially pumping blood into a corpse hoping for some fleeting sign of life. But dead is dead. Capitalism requires capital. This is the disturbing truth behind securitization — which was not developed to allocate resources to productive activity more efficiently but to allow credit expansion on smaller and smaller chunks of capital, further enriching a handful of well-connected speculators. This is the sole function of off-balance sheets operations and unregulated derivatives — to conceal the abysmal lack of capital that supports the debt. When trillions of dollars in complex debt-instruments, derivatives contracts, and loans to unqualified applicants are stacked atop a tiny scrap of capital, disaster is inevitable.

Bernanke is now busy sifting through the rubble trying to reassemble Wall Street’s Golden Goose for one-last wild credit fling, but with no luck. So far, he’s come up snake-eyes, which is probably best for everyone.

Ben Bernanke:

The depth and breadth of the global recession has required a highly accommodative monetary policy. Since the onset of the financial crisis nearly two years ago, the Federal Reserve has reduced the interest-rate target for overnight lending between banks (the federal-funds rate) nearly to zero. We have also greatly expanded the size of the Fed’s balance sheet through purchases of longer-term securities and through targeted lending programs aimed at restarting the flow of credit…. My colleagues and I believe that accommodative policies will likely be warranted for an extended period.

No talk of recovery here; just a continuation of the same radical policies that were adopted after the collapse of Lehman Bros. The only sign of improvement has been in the stock market, where Bernanke’s liquidity injections have jolted equities back to life. The S&P 500 is up 40% since March. Conditions in the broader economy have continued to deteriorate as unemployment rises, the states find it harder to balance their budgets, and the real estate bubble (commercial and residential) continues to unwind. The Fed’s policies are Bernanke’s way of saying, “The states are not the country. The banks are the country.”

Bernanke’s op-ed is a public relations ploy intended to soften the effects of his visit to Capital Hill today. Congress wants to know the Fed chief’s “exit strategy” for soaking up all the money he’s created and avoiding inflation.

Bernanke again:

The exit strategy is closely tied to the management of the Federal Reserve balance sheet. When the Fed makes loans or acquires securities, the funds enter the banking system and ultimately appear in the reserve accounts held at the Fed by banks and other depository institutions. These reserve balances now total about $800 billion, much more than normal. And given the current economic conditions, banks have generally held their reserves as balances at the Fed.

This is the core issue. The Fed has built up bank reserves by accepting (mainly) mortgage-backed garbage (MBS) that is worth only pennies on the dollar. Bernanke assumes that investors will eventually recognize their mistake and begin to purchase these toxic assets at a price that won’t bankrupt the banking system. It’s a complete hoax and everyone knows it. In essence, Bernanke is saying that he is right and the market is wrong, which is why he continues to conceal the fact that he provided full-value loans for collateral which the banks will never be able to repay. The costs, of course, will eventually be shifted onto the taxpayer.

Bernanke knows that the country is in a Depression and that inflation won’t be a problem for years to come. It’s all politics. Bank lending is way off and the shadow banking system–which provided over 40% of consumer credit via securitization–is still on life-support. At the same time, the savings rate has spiked to 6.9%–a 15 year high–as consumers cut back on spending to service their debt-load, and try to make up for the $14 trillion in lost household wealth since the crisis began. If the banks aren’t lending and consumers aren’t spending, inflation is impossible.

Bernanke’s zero-percent interest rates and lending facilities have been a total bust. The velocity of money (how fast money changes hands) has stopped. Retail is down 9% year-over-year. Imports/exports down 20%. Rail freight and shipping at historic lows. Travel, manufacturing, hotels, restaurants are all in the tank. The economy is flat-lining. Only Goldman and JPM have done well in this environment, and that’s because the White House is a Goldman-annex.

The only Bernanke policy that’s worked so far has been flooding the market with money, which has has sent equities into orbit while the real economy continues to twist in the wind. Here’s how former hedge fund manager Andy Kessler summed it up last week in the Wall Street Journal:

By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn’t put money directly into the stock market but he didn’t have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear. Stock and bond funds saw net inflows of close to $150 billion since January. The dollars he cranked out didn’t go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market.¹

Bernanke’s quantitative easing (QE) has pumped up bank stocks enough so that Geithner won’t have to grovel to Congress for another TARP bailout. The banks now have access to the capital markets and can withstand the stormy downgrades ahead. Thus, the nagging problem of toxic assets has been solved (temporarily) just as Bernanke had planned.

Bernanke will continue to monetize the debt (by purchasing more US Treasuries and MBS) until securitization is restored and there are signs of life in the failed wholesale credit-system. That’s the real objective; to keep credit expansion in the hands of privately-owned financial institutions that are beyond the reach of government regulation. The Fed’s so-called mandate of “full employment and price stability” is pure malarkey. The Fed’s job is to provide an endless stream of cheap capital to Wall Street. By that standard, Bernanke has performed his task admirably.

1. Andy Kessler, “The Bernanke Market,” Wall Street Journal.

In the next year, China will buy roughly $200 billion T-Bills while the oil producing states and the rest of the world will add about $300 billion to their stash. That leaves more than $2 trillion for the domestic market where cash-strapped investors are likely to avoid government debt like the plague. So, who’s going buy that mountain of low-yield government paper?

The banks.

The Fed has been helping the banks raise reserves for the last year. In fact, excess bank reserves have skyrocketed from $96.5 billion in August 2008 to $949.6 billion by April 2009. Nearly a trillion bucks in less than a year. But, why? Are the banks expecting to expand lending at the fastest rate in history in the middle of a depression?

No way; that’s why Master illusionist Bernanke is arranging the props for his next big “Hocus-pocus”. The fact is, Bernanke anticipated the current wave of deflation and set up a straw man (the banks) to deal with it so it wouldn’t look like he was simply printing more greenbacks to finance the deficits. As soon as rates on 10-year notes hit 4%, the banks (that are borrowing money at 0%) will probably start to purchase Treasuries and keep the housing and retail markets from crashing even faster. It’s called “the old switcheroo” and no one does it better than the Fed.

Bernanke pulled a similar stunt after Lehman Bros flopped and he and Paulson decided that it was time to dump 700 billion worth of garbage assets on the public. The Fed chief and Treasury figured out the only way they could hoodwink congress was to stir up a crisis in the credit markets and then moan that if they didn’t get $700 billion to buy up toxic assets in the next 48 hours “there wouldn’t be an economy by Monday”. (I’m not making this up)

Congress swallowed it hook, line and sinker, and weeks later the funds were allocated for the Troubled Asset Relief Program (TARP). Of course, no one in the financial media noticed that the turmoil in the credit markets was NOT caused by “troubled assets” at all (for which TARP funds have NEVER been used) but by skyrocketing LIBOR and TED spreads and other indicators of market stress. Market Ticker’s Karl Denninger was the only blogger on the Internet who figured out that Bernanke had deliberately caused the crisis by draining over $100 billion from the banking system just 10 days after Lehman defaulted. Here are Denninger’s comments on September 24, 2008 along with the damning chart which proves the Fed was scuttling the ship to extort money from congress:

Market Ticker: “Note that this is an intentional drain of “slosh”, or liquidity, from the banking system. $125 billion in the last four days drained?²

“It appears to me that he (Bernanke) both orchestrated the crash of the market in the fall of 2008 as a leverage tool to force the passage of the TARP and may have been responsible for Washington Mutual’s collapse and forced dismemberment.

Let us remember that on September 20th, four days prior to Bernanke’s action, Henry Paulson pitched TARP (along with Bernanke) to Congress.”³

As soon as Paulson and Bernanke had pulled off their multi-billion dollar heist, the Fed chief created lending facilities (completely unrelated to the TARP) which provided government guarantees on money markets and commercial paper. This lowered LIBOR and TED spreads immediately and relieved the stress in the credit markets. The crisis had nothing to do with toxic assets; it was a cheap parlor trick by a professional charlatan. To this day, none of the junk securities have been purchased from the banks under the TARP program. $700 billion has vanished in a puff of smoke.

Poof!

1. “Treasuries Tumble as Jobs Report Renews Fed Rate Speculation,” Bloomberg.
2. “Congress must Excise the Bernanke Cancer,” Market Ticker.
3. Market Ticker.

It’s important to realize that there’s no hint of inflationary pressures in the economy right now. Consumer prices are lower now than they were a year ago, and wage increases have stalled in the face of high unemployment. Deflation, not inflation, is the clear and present danger….

Is there a risk that we’ll have inflation after the economy recovers? That’s the claim of those who look at projections that federal debt may rise to more than 100 percent of G.D.P. and say that America will eventually have to inflate away that debt — that is, drive up prices so that the real value of the debt is reduced…. Such things have happened in the past…

Some economists have argued for moderate inflation as a deliberate policy, as a way to encourage lending and reduce private debt burdens (but)… there’s no sign it’s getting traction with U.S. policy makers now.”¹

Krugman believes that conservatives have conjured up the inflation hobgoblin for political purposes to knock Obama’s recovery plan off-course. But even he’s mistaken, there’s little chance that inflation will flare up anytime soon because the economy is still contracting, albeit at a slower pace than before. A good chunk of the Fed’s liquidity is sitting idle in bank vaults instead of churning through the system as Bernanke it could do some good. According to Econbrowser, excess bank reserves have bolted from $96.5 billion in August 2008 to $949.6 billion by April 2009. Bernanke hoped the extra reserves would help jump-start the economy, but he was wrong. The people who need credit, can’t get it; while the people who qualify, don’t want it. It’s just more proof that the slowdown is spreading.

That doesn’t mean that the dollar won’t tumble in the next year or so when the trillion dollar deficits begin to pile up. It probably will. Foreign investors have already scaled back on their dollar-based investments, and central banks are limiting themselves to short-term notes, mostly 3 month Treasuries. If Bernanke steps up his quantitative easing (QE) and continues to monetize the debt, there’s a good chance that central bankers will jettison their T-Bills and head for the exits. That means that if keeps printing money like he has been, there’s going to be a run on the dollar.

Now that the stock market is showing signs of life again, investors are moving out of risk-free Treasuries and into equities. That’s pushing up yields on long-term notes which could potentially short-circuit Bernanke’s plans for reviving the economy. Mortgage rates are set off the 10-year Treasury, which shot up to 3.90% by markets’ close on Friday. The bottom line is that if rates keep rising, housing prices will plummet and the economy will tank. This week’s auctions will be a good test of how much interest there really is in US debt.

At some point in the next year, the dollar will lose ground and commodities will surge, causing uneven inflation. But for how long? That depends on the state of the economy. Dollar weakness and speculation can drive up the price of oil, (oil is up 100% in the last two and a half months, from $34. to $68.) but falling demand will eventually bring prices back to earth. Presently, there’s a bigger glut of oil sitting in tankers offshore than anytime in the last 15 years. Which brings us back to the original question; how bad is the economy?

The answer is, really bad! Here’s a short blurb from economist Dean Baker in an article in the UK Guardian:

The decline in house prices since the peak in 2006 has cost homeowners close to $6 trillion in lost housing equity. In 2009 alone, falling house prices have destroyed almost $2 trillion in equity. People were spending at an incredible rate in 2004-2007 based on the wealth they had in their homes. This wealth has now vanished.

Housing is weak and falling, consumption is weak and falling, new orders for capital goods in April, the main measure for investment demand, is down 35.6 percent from its year ago level. And, state and local governments across the country, led by California, are laying off workers and cutting back services.

If there is evidence of a recovery in this story it is very hard to find. The more obvious story is one of a downward spiral as more layoffs and further cuts in hours continue to reduce workers’ purchasing power. Furthermore, the weakness in the labor market is putting downward pressure on wages, reducing workers’ purchasing power through a second channel.²

Don’t be fooled by the cheery news in the media. The economy is hanging by a thread and recovery is still a long way off. The only way to dig out of this mess is to address the underlying problems head-on. That means removing the toxic assets from the banks, revamping the credit system, and rebuilding battered household balance sheets. If these issues aren’t resolved, the problems will drag on for years to come. And even if they are fixed, the economy is still facing a long period of deleveraging and retrenching followed by an anemic recovery. Obama’s fiscal stimulus might give GDP a jolt in the third quarter, but without help from the government checkbook, economic activity will stay in the doldrums.

Last month, personal savings increased to nearly 6 percent while consumer credit fell by $15.7 billion, the second largest decline in debt on record. According to Brad Setser of the Council on Foreign Relations, “Total borrowing by households and firms fell from over 15% of GDP in late 2007 to a negative 1% of GDP in q4 2008.” How can these losses to GDP be made up when private borrowing has vanished without a trace? Consumers have shut their wallets, locked their purses and are refusing to take on any more debt. Despite government efforts to restart the credit markets by backing up loans for 0% financing on auto sales and $8,000 tax credit on the purchase of a new home, (which is tantamount to subprime lending) consumers are digging in their heels. All the hype about inflation hasn’t sent them racing back to the shopping malls or the auto showrooms. Consumers have reached their saturation point and they are not budging. It’s the end of an era.

The unemployment picture is getting bleaker and bleaker. Last week’s report from the Bureau of Labor Statistics concealed the real magnitude of the job losses by using the discredited “Birth-Death” model which exaggerates the number of people reentering the workforce. Here’s what former Merrill Lynch chief economist David Rosenberg had to say about Friday’s BLS report:

The headline nonfarm payroll figure came in above expectations at — 345,000 in May — the consensus was looking for something closer to -525,000. The markets are treating this as yet another in the line-up of ‘green shoots’ because the decline was less severe than it was in April (-504,000), March (-652,000), February (-681,000) and January (-741,000). However, let’s not forget that the fairy tale Birth-Death model from the Bureau of Labour Statistics (BLS) added 220,000 to the headline — so adjusting for that, we would have actually seen a 565,000 headline job decline.

The BLS figures have been denounced by every econo-blogger on the Internet. The figures are another example of the government’s determination to airbrush any unpleasant news about the recession. Here’s a better summary of the unemployment numbers from Edward Harrison at Credit Writedowns:

The Business Birth-Death Model added 220,000 jobs to the headline seasonally-adjusted number. Without this number, we are looking at a loss of 565,000 jobs….The number of jobs lost in the last 12 months increased from 5.34 million in April to 5.51 million in May….Other indicators suggest that the shadow supply of discouraged workers not counted in the numbers will now return to the labor force, pushing up the unemployment number. For example, the U-6 unemployment number was a gargantuan 16.4 %, the highest ever.³

Unemployment now stands at 9.4% (16.4%?) and will continue to rise whether there’s an uptick in economic activity or not. Businesses are shedding jobs at record pace, and slashing hours at the same time. The average workweek slipped to 33.1 hours (down 2 hours from April) a new low. It goes without saying, that unemployment is highly deflationary because jobless people have to cut out all unnecessary spending. Beyond the 500,000 layoffs per month; wages and benefits are also under pressure, making a rebound in consumer spending even less probable. This is from Brian Pretti’s article “Place Your Wagers”:

The year over year change in the Employment Cost Index (ECI) is the lowest number in the history of the data… in the absence of household credit acceleration… aggregate demand (will fall)

The year over year change in wages has never been this low in the records of the data. .. Wages and salaries… are all in negative rate of change territory. They are ALL contracting year over year.

Absent household balance sheet reacceleration in leverage it sure seems a good bet forward corporate earnings are now as dependent on household wages, salaries and broader personal income as at any time in recent memory. And corporations to protect margins and nominal profits are pressuring wages and salaries downward.⁴

From a workers point of view, things have never been worse. Demand is falling, employers are slashing inventory and handing out pink slips, and entire industries are being boarded up and shut down or shipped overseas. Economists Barry Eichengreen and Kevin O’Rourke make the case that, in many respects, conditions are deteriorating faster now than they did in the 1930s. Here’s what they found:

1–World industrial production continues to track closely the 1930s fall, with no clear signs of ‘green shoots’.

2–World stock markets have rebounded a bit since March, and world trade has stabilized, but these are still following paths far below the ones they followed in the Great Depression.

3–The North Americans (US & Canada) continue to see their industrial output fall approximately in line with what happened in the 1929 crisis, with no clear signs of a turn around.⁵ Their conclusion: “Today’s crisis is at least as bad as the Great Depression.”

Yeah, times are tough, but what happens when housing prices stabilize and the jobs market begins to pick up; won’t that put the Fed’s trillions of dollars into circulation and create Wiemar-type hyperinflation?

Many people think so, but Edward Harrison anticipates a completely different scenario. The author takes into account the psychological effects of a deep recession and shows how trauma can have a lasting effect on consumer habits, thus, minimizing the chance of inflation. It’s a persuasive thesis. Here’s what he says:

Richard Koo goes further in his book The Holy Grail of Macro Economics. Here, he argues that the unwind of great bubbles suffers from what he labels a ‘balance sheet recession.’ In essence, companies go from maximizing profits, as they had done in normal times, to a post-bubble concern of reducing debt. Regardless of how much priming of the pump monetary authorities do, the psychology of debt reduction will limit the effectiveness of monetary policy as a policy tool.

In my view, the catalyst for this change of psychology is the ‘debt revulsion’ that ushers in the panic phase of an asset bubble collapse. (Charles Kindleberger highlights the various stages of a bubble and its implosion in his seminal book Manias, Panics and Crashes. In this particular bubble, debt revulsion began post-Lehman Brothers. What we have seen, therefore, is a reduction in leverage and debt as the most leveraged players have gone to the wall. But, more than that, the household sector has gotten religion about debt reduction as the savings rate has increased dramatically since Lehman. In fact, I would argue that companies learned their lesson about debt from the aftermath of the tech bubble. It is the household sector in the U.S. (and the U.K.) which is heavily indebted. Therefore, if the psychology of a balance sheet recession does take form, it will be the household sector leading the charge.

In sum, the psychology after a major bubble is very different than the psychology before its collapse. The post-bubble emphasis becomes debt reduction and savings, making monetary policy ineffective, not because financial institutions are unwilling lenders but because companies and individuals are unwilling borrowers. These are forces to be reckoned with for some to come.⁶

Seductive interest rates, lax lending standards and nonstop public relations campaigns, persuaded millions of people that they could live beyond their means by simply filling out a credit app. or fudging a few numbers on a mortgage loan. These are the real victims of Wall Street’s speculative bubble-scam. For many of them, the agony of losing their home, or their job, or filing for personal bankruptcy will be felt for years to come. At the same time, the experience will keep many of them from getting in over their heads again. The same phenomenon occurred during the Great Depression. The pain of losing everything shapes behavior for a lifetime, which is why the savings rate has spiked so dramatically in the last few months. There’s been a tectonic shift in attitudes towards consumption and there’s no going back to the pre-bubble era.

If Harrison is right, our decades-long spending-spree is over and people will be looking for ways to live more modestly, pay-as-they-go and avoid red ink. This is good news for the economy’s long-term strength, but bad for short-term recovery. Deflation will persist even while savings grow and consumption comes more into line with personal income. The dollar will fall hard if Bernanke continues to load up on Treasuries, but with a few slight adjustments, he should be able to avoid a full-blown currency crisis. Thus, Zimbabwe-type hyperinflation is unlikely; the ongoing slowdown should keep inflation in check.

1. ”The Big Inflation Scare,” Paul Krugman, New York Times.
2. Dean Baker “Cheerleading the Economy,” UK Guardian.
3. Edward Harrison credit writedowns.
4. ”Place Your Wagers,” Brian Pretti, Financial Sense Observations.
5. ”A Tale of Two Depressions,” Barry Eichengreen and Kevin O’Rourke, VOX.
6. Edward Harrison, “Central banks will face a Scylla and Charybdis flation challenge for years” Credit Writedowns.

It’s not only possible, it’s been done. And now the scoundrels who cashed in on the swindle have lined up outside the Federal Reserve building to trade their garbage paper for billions of dollars of taxpayer-funded loans. Where’s the justice? Meanwhile, the credit bust has left the financial system in shambles and driven the economy into the ground like a tent stake. Maxed-out consumers are cutting back on everything from nights-out-on-the-town to trips to the grocery store while the unemployment lines are growing longer in every city across the country. And it’s all due to a Ponzi-finance scam that was concocted on Wall Street and spread through the global system like an aggressive strain of Bird Flu. It’s called securitization, and it is at the very heart of the financial meltdown.

Securitization — which is the conversion of pools of loans into securities that are sold in the secondary market — provides a means for massive debt leveraging. The banks use off-balance sheet operations to create securities so they can avoid normal reserve requirements and bothersome regulatory oversight. Oddly enough, the quality of the loan makes no difference at all, since the banks make their money on loan originations and other related fees. What matters is quantity, quantity, quantity; an industrial-scale assembly line of fetid loans dumped on unsuspecting investors to fatten the bottom line. And, boy, can Wall Street grind out the rotten paper when there’s no cop on the beat and the Fed is cheering from the bleachers.

In an analysis for the Federal Reserve Bank of Atlanta’s 2009 Financial Markets Conference, titled “Slapped in the Face by the Invisible Hand; Banking and the Panic of 2007,” economist Gary Gorton shows that mortgage-related securities ballooned from $492.6 billion in 1996 to $3,071.1 in 2003, while asset backed securities (ABS) jumped from $168.4 billion in 1996 to $1,253.1 in 2006. All told, more than $20 trillion in securitized debt was sold between 1997 to 2007. How much of that debt will turn out to be worthless as foreclosures skyrocket and the banks balance sheets come under greater and greater pressure?

Deregulation opened Pandora’s box, unleashing a weird mix of shady off-book operations (SPVs, SIVs) and dodgy, odd-sounding derivatives that were used to amplify leverage and stack debt on tinier and tinier scraps of capital. It’s easy to make money, when one has no skin in the game. That’s how hedge fund managers and private equity sharpies get rich. Securitization gave the banks the opportunity to take substandard loans from applicants who had no way of paying them back, and magically transform them into Triple A securities. Abracadabra. The Wall Street public relations throng boasted that securitization “democratized” credit because more people could borrow at better rates since funding came from investors rather than banks. But it was all a hoax. The real objective was to turbo-charge profits by skimming hefty salaries and bonuses on the front end, before people found out they’d been hosed. The former head of the FDIC, William Seidman, figured it all out back in 1993 when he was cleaning up after the S&L fiasco. Here’s what he said in his memoirs:

“Instruct regulators to look for the newest fad in the industry and examine it with great care. The next mistake will be a new way to make a loan that will not be repaid.” (Bloomberg)

That’s it in a nutshell. The banks never expected the loans would be paid back, which is why they issued them to ninjas: applicants with no income, no collateral, no job, and a bad credit history. It made no sense at all, especially to anyone who’s ever sat through a nerve-wracking credit check with a sneering banker. Trust me, bankers know how to get their money back, if that’s their real intention. In this case, it didn’t matter. They just wanted to keep their counterfeiting racket zooming ahead at full-throttle for as long as possible. Meanwhile, Maestro Greenspan waved pom-poms from the sidelines, extolling the virtues of the “new economy” and the permanent high plateau of prosperity that had been achieved through laissez faire capitalism.

Now that the securitization bubble has burst, 40% of the credit that had been coursing into the economy has been cut off triggering a 1930’s-type meltdown. Fed chief Bernanke has stepped into the breach and provided a $13 trillion dollar backstop to keep the financial system from collapsing, but the broader economy has continued its historic nosedive. Bernanke is trying to fill the chasm that opened up when securitization ground to a halt and gas started exiting the credit bubble in one mighty whooosh. The deleveraging is ongoing, despite the Fed’s many programs to rev up securitization and restore speculative bubblenomics. Bernanke’s latest brainstorm, the Term Asset-backed securities Lending Facility (TALF), provides 94 percent public funding for investors willing to buy loans backed by credit card debt, student loans, auto loans or commercial real estate loans. It’s a “no lose” situation for big investors who think that securitized debt will stage a comeback. But that’s the problem; no one does. Attractive, non-recourse (nearly) risk free loans have failed to entice the big brokerage houses and hedge fund managers. Bernanke has peddled less than $30 billion in a program that’s designed to lend up to $1 trillion. It’s been a complete bust.

To understand securitization, one must think like a banker. Bankers believe that profits are constrained by reserve requirements. So, what they really want is to expand credit with no reserves; the equivalent of spinning flax into gold. Securitization and derivatives contracts achieve that objective. They create a confusing netherworld of odd-sounding instruments and bizarre processes which obscure the simple fact that they are creating money out of thin air. That’s what securitization really is: undercapitalized junk masquerading as precious jewels. Here’s how economist Henry CK Liu sums it up in his article “Mark-to-Market vs. Mark-to-Model“:

The shadow banking system has deviously evaded the reserve requirements of the traditional regulated banking regime and institutions and has promoted a chain-letter-like inverted pyramid scheme of escalating leverage, based in many cases on nonexistent reserve cushion. This was revealed by the AIG collapse in 2008 caused by its insurance on financial derivatives known as credit default swaps (CDS) . . . .

The Office of the Comptroller of the Currency and the Federal Reserve jointly allowed banks with credit default swaps (CDS) insurance to keep super-senior risk assets on their books without adding capital because the risk was insured. Normally, if the banks held the super-senior risk on their books, they would need to post capital at 8% of the liability. But capital could be reduced to one-fifth the normal amount (20% of 8%, meaning $160 for every $10,000 of risk on the books) if banks could prove to the regulators that the risk of default on the super-senior portion of the deals was truly negligible, and if the securities being issued via a collateral debt obligation (CDO) structure carried a Triple-A credit rating from a “nationally recognized credit rating agency”, such as Standard and Poor’s rating on AIG.

With CDS insurance, banks then could cut the normal $800 million capital for every $10 billion of corporate loans on their books to just $160 million, meaning banks with CDS insurance can loan up to five times more on the same capital. The CDS-insured CDO deals could then bypass international banking rules on capital.

The same rule applies to derivatives (CDS) as securitized instruments; neither is sufficiently capitalized because setting aside reserves impairs one’s ability to maximize profits. It’s all about the bottom line. The reason credit default swaps are so cheap, compared to conventional insurance, is that there’s no way of knowing whether the dealer has the ability to pay claims. It’s fraud, on a gigantic scale, which is why the financial system went into full-blown paralysis when Lehman Bros defaulted. No one knew whether trillions of dollars in counter-party contracts would be paid out or not. There are simply more claims on wealth than there is money in the system. Bogus mortgages and phony counter-party promises mean nothing. “Show me the money.” The system is underwater, and it cannot be fixed by more of the Fed’s presto liquidity. Here’s what Gary Gorton says later in the same article:

A banking panic means that the banking system is insolvent. The banking system cannot honor contractual demands; there are no private agents who can buy the amount of assets necessary to recapitalize the banking system, even if they knew the value of the assets, because of the sheer size of the banking system. When the banking system is insolvent, many markets stop functioning and this leads to very significant effects on the real economy . . . .

Indeed. The shadow banking system has collapsed, not because the market is “frozen” or because investors are in a state of panic after Lehman, but because derivatives and securitization have been exposed as a fraud propped up on insufficient capital. It’s snake oil sold by charlatans. That’s why European policymakers are resisting the Fed’s requests to create a facility similar to the TALF to start up securitization again. Here’s a revealing clip from the Wall Street Journal, which explains what’s going on behind the scenes:

Bankers are pushing European policy makers to consider a U.S.-style program to aid the region’s economy by reviving the moribund market for bundled consumer loans. Officials at the European Securitisation Forum, a trade group representing banks and other market participants, said Tuesday that central bankers should consider stepping in with a program similar to the U.S. Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF, which provides loans to private investors who buy new securities tied to consumer loans . . .

After suffering heavy losses on securities stuffed with poorly made loans, investors are reluctant to wade back in, and Europe lacks big players like the Pacific Investment Management Co. in the U.S., whose buying can mobilize other investors….The market also faces uncertainty over how European regulators will change the rules of the game, in part by imposing tougher capital requirements on banks, the main buyers of securitized assets in Europe.

One European Commission proposal would dramatically hike the capital required of banks holding a securitized asset if the originator allowed its share of that asset to fall below a 5% threshold . . .

Paul Sharma of Britain’s Financial Services Authority said regulatory action is likely to shrink the investor base for ABS, in part by increasing the capital cushions banks will have to hold against ABS holdings in their trading books. He also argued that ABS were inappropriate for banks to hold as liquid assets, because they have proven difficult to sell in a market crisis.

“There is very much a query in the minds of regulators as to whether there is a significant future for securitization,” said Mr. Sharma, though he added his own view was that the market did have a future role. (”In Europe, a U.S. Way To Fix ABS Market?,” Neil Shah and Stephen Fidler, Wall Street Journal)

See? In Europe regulators still do their jobs and make sure that financial institutions have money before they create trillions of dollars in credit. They don’t stick with their heads in the sand while crooked bankers fleece the public. Bernanke’s job is to step in and put an end to the hanky-panky, not add to the problems by restoring a credit-generating regime that transferred hundreds of billions of dollars from ordinary hard-working people to fat cat banksters and Wall Street flimflammers.

Export-led nations are looking for an edge to revive flagging sales by keeping their currencies undervalued. But the strong dollar is making it harder for Bernanke to engineer a recovery. He’d like nothing more than to see the dollar tumble and reset at a lower rate. That would reduce the debt-load for homeowners and businesses and send consumers racing back to the shopping malls and auto showrooms. Perception management is a big part of stimulating the economy. That’s why the financial media has been air-brushing articles that focus on deflation and shifting the attention to inflation. It’s an effort to kick start consumer spending by convincing people that their money will be worth less in the future. But deflation is still enemy number one. Rising unemployment, crashing home prices, vanishing equity and tighter credit; these are all signs of entrenched deflation.

Bernanke faces three main challenges to put the economy back on track. He must remove the hundreds of billions in toxic assets from the banks balance sheets, reignite consumer spending to offset the sharp decline in aggregate demand, and fix the wholesale credit-mechanism that provides 40 percent of the credit to the broader economy. Treasury Secretary Timothy Geithner has taken over the distribution of the remaining TARP funds, and created a new program, the Public-Private Investment Partnership (PPIP), for purchasing toxic mortgage-backed assets. The PPIP will provide up to 94 percent “non-recourse” government loans for up to $1 trillion of assets which are worth less than half of their original value at today’s prices. The Treasury’s plan is an attempt to keep asset prices artificially high so that the losses will not be realized until they’ve been shifted onto the taxpayer. Here’s how John Hussman of Hussman Funds summed up Geithner’s PPIP:

From early reports regarding the toxic assets plan, it appears that the Treasury envisions allowing private investors to bid for toxic mortgage securities, but only to put up about 7% of the purchase price, with the TARP matching that amount – the remainder being “non-recourse” financing from the Fed and FDIC. This essentially implies that the government would grant bidders a put option against 86% of whatever price is bid. This is not only an invitation for rampant moral hazard, as it would allow the financing of largely speculative and inefficiently priced bids with the public bearing the cost of losses, but of much greater concern, it is a likely recipe for the insolvency of the Federal Deposit Insurance Corporation, and represents a major end-run around Congress by unelected bureaucrats.

Make no mistake — we are selling off our future and the future of our children to prevent the bondholders of U.S. financial corporations from taking losses. We are using public funds to protect the bondholders of some of the most mismanaged companies in the history of capitalism, instead of allowing them to take losses that should have been their own. All our policy makers have done to date has been to squander public funds to protect the full interests of corporate bondholders. Even Bear Stearns bondholders can expect to get 100% of their money back, thanks to the generosity of Bernanke, Geithner and other bureaucrats eager to hand out the money of ordinary Americans. (John Hussman, “The Fed and Treasury — Putting off Hard Choices with Easy Money, and Probable Chaos”)

The second part of the Fed’s plan is to fix the wholesale credit-mechanism, which means restoring the securitization markets where pools of loans are transformed into securities and sold to investors. Until Bernanke is able to lure investors back into purchasing high-risk debt-instruments comprised of student loans, mortgage securities, auto loans and credit card debt, the credit markets will continue sputter and growth will be flat. Structured-debt creates the asset base which is leveraged though traditional loans or complex derivatives. Credit expansion maximizes profit, inflates asset prices and establishes the structural framework for shifting wealth to financial institutions via speculative asset bubbles. This is the basic financial model that US banks and financial institutions hope to export to the rest of the industrial world to ensure a greater portion of global wealth for themselves and a stronger grip on the political process.

Bernanke’s Term Asset-backed Securities Loan Facility (TALF) provides up to $1 trillion in non recourse loans to financial institutions willing to buy AAA-rated debt-instruments backed by consumer and small business loans. So far, the response has been tepid at best. For all practical purposes, the market is still frozen. Bernanke knows that there will be no recovery unless the credit markets are functioning properly. He also knows that the TALF won’t succeed unless he provides guarantees for the underlying collateral, which is loans that were made to applicants who have no means for paying them back. Bernanke’s guarantees will cost the taxpayer billions of dollars without any assurance that his plan will even work. It’s a complete fiasco.

From the Federal Reserve Bank of San Francisco Economic Letter, “US Household Deleveraging and Future consumption Growth” by Reuven Glick and Kevin J. Lansing:

More than 20 years ago, economist Hyman Minsky (1986) proposed a “financial instability hypothesis.” He argued that prosperous times can often induce borrowers to accumulate debt beyond their ability to repay out of current income, thus leading to financial crises and severe economic contractions.

Until recently, U.S. households were accumulating debt at a rapid pace, allowing consumption to grow faster than income. An environment of easy credit facilitated this process, fueled further by rising prices of stocks and housing, which provided collateral for even more borrowing. The value of that collateral has since dropped dramatically, leaving many households in a precarious financial position, particularly in light of economic uncertainty that threatens their jobs.

Going forward, it seems probable that many U.S. households will reduce their debt. If accomplished through increased saving, the deleveraging process could result in a substantial and prolonged slowdown in consumer spending relative to pre-recession growth rates. Alternatively, if accomplished through some form of default on existing debt, such as real estate short sales, foreclosures, or bankruptcy, deleveraging could involve significant costs for consumers, including tax liabilities on forgiven debt, legal fees, and lower credit scores. Moreover, this form of deleveraging would simply shift the problem onto banks that hold these loans as assets on their balance sheets. Either way, the process of household deleveraging will not be painless. (The Federal Reserve Bank of San Francisco Economic Letter, “US Household Deleveraging and Future consumption Growth” by Reuven Glick and Kevin J. Lansing)

The economy is in the grip of deflation. Commercial banks are stockpiling excess reserves (more than $850 billion in less than a year) to prepare for future downgrades, write-offs, defaults and foreclosures. That’s deflation. Consumers are cutting back on discretionary spending; driving, eating out, shopping, vacations, hotels, air travel. More deflation. Businesses are laying off employees, slashing inventory, abandoning plans for expansion or reinvestment. More deflation. Banks are trimming credit lines, calling in loans and raising standards for mortgages, credit cards and commercial real estate. Still more deflation. Bernanke has opened the liquidity valves to full-blast, but consumers are backing off; they’re too mired in debt to borrow, so the money sits idle in bank vaults while the economy continues to slump.

In an environment where businesses and consumers are rebuilding their balance sheets and paying off debt, there’s only one option; inflation. Bernanke will keep interest rates will stay low while increasing monetary and fiscal stimulus. The ocean of red ink will continue to rise. Still, the system-wide contraction will persist despite the Fed’s multi-trillion dollar lending programs, quantitative easing (QE) and Treasury buybacks. The “Great Unwind” is irreversible; the era of limitless credit expansion is over.

David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, believes that the equities markets have undergone a “gargantuan short-cover rally” and that stocks will retest the March 9th low, which was a 12 year low for the S&P 500 Index. Rosenberg said he doesn’t expect the economy to recover in the second half of the year.

“I’m seeing no revival of consumer spending in the second quarter,” Rosenberg said. (Bloomberg)

The conditions that supported the explosive growth of the last decade no longer exist. The credit markets are in a shambles, the banking system is hanging by a thread, and the consumer is out of gas. Traders are clinging to the slim hope that the worst is over, but they could be mistaken. There’s probably another leg down and it will be more vicious than the last.

From Tyler Durden at Zero Hedge:

In order to fully understand currency and price movements, one has to realize that the securitization of debt, and creation of derivatives amounted to a huge virtual printing press, primarily fueled by a massive increase in risk appetite which allowed for a huge expansion in the value of claims on financial assets and goods and services. It is worth pointing out, that the Fed has little to no control over this “printing press” at this point, which at last count was responsible for over 90% of the liquidity in the system.

The faux-prosperity of the last decade was largely the result of a wholesale credit system, which created a humongous amount of credit via sketchy debt instruments, off-balance sheet operations, massive leverage and derivatives. (The Fed’s liquidity and conventional bank loans play a very small part in the modern credit system) Securitization — which is the conversion of pools of loans into securities — is at the center of the storm. It formed the asset base upon which the investment banks and hedge funds stacked additional leverage creating an unstable debt pyramid that couldn’t withstand the battering of a slumping market. After two Bear Stearns funds defaulted 20 months ago, the securitization markets froze, credit dried up and the broader economy went into a tailspin. Now that investors know how risky securitized instruments really are, there’s little chance that assets will regain their original value or that the market for structured debt will stage a comeback.

Bernanke’s Term Asset-backed Loan Facility (TALF) is an attempt to restore the crashed system by offering participants generous government funding to purchase securities backed by mortgages, student loans, auto loans and credit card debt. But skittish investors have stayed on the sidelines. The severity of the downturn has dampened the appetite for risk. So Bernanke has cranked up the money supply, cut interest rates to zero and flooded the financial system with liquidity. His actions have convinced many of the experts that the country is on the fast track to hyperinflation, but that may not be the case, as explained in the Hoisington Investment Management’s Quarterly Economic Review:

Despite near term deflation risks, the overwhelming consensus view is that “sooner or later” inflation will inevitably return, probably with great momentum.

This inflationist view of the world seems to rely on two general propositions. First, the unprecedented increases in the Fed’s balance sheet are, by definition, inflationary. The Fed has to print money to restore health to the economy, but ultimately this process will result in a substantially higher general price level. Second, an unparalleled surge in federal government spending and massive deficits will stimulate economic activity. This will serve to reinforce the reflationary efforts of the Fed and lead to inflation.

(But) let’s assume for the moment that inflation rises immediately. With unemployment widespread, wages would seriously lag inflation. Thus, real household income would decline and truncate any potential gain in consumer spending…

Inflation will not commence until the Aggregate Demand (AD) Curve shifts outward sufficiently to reach the part of the Aggregate Supply (AS) curve that is upward sloping…..Therefore, multiple outward shifts in the Aggregate Demand curve will be required before the economy encounters an upward sloping Aggregate Supply Curve thus creating higher price levels. In our opinion such a process will take well over a decade. . . .

The statement that all the Fed has to do is print money in order to restore prosperity is not substantiated by history or theory. An increase in the stock of money will only lead to a higher GDP if V, or velocity, is stable. V should be thought of conceptually rather than mechanically. If the stock of money is $1 trillion and total spending is $2 trillion, then V is 2. If spending rises to $3 trillion and M2 is unchanged, velocity then jumps to 3.

. . . The historical record indicates that V may be likened to a symbiotic relationship of two variables. One is financial innovation and the other is the degree of leverage in the economy. Financial innovation and greater leverage go hand in hand, and during those times velocity is generally above its long-term average.

As the shadow banking system continues to collapse, velocity should move well below its mean, greatly impairing the efficacy of monetary policy…The problem for the Fed is that it does not control velocity or the money created outside the banking system. (Thanks to Leo Kolivakis, of Pension Pulse, “Is Inflation inevitable?“)

Bernanke can print as much money as he wants, but if the banks are hoarding, consumers are saving, businesses are cutting back, and all the money-multipliers are set to “Off”; there will be no inflation. Demand has to pick up, so that money begins to change hands quickly leading to vast amounts of new money competing for the same number of assets. But that won’t happen while the economy is shedding 600,000 jobs a month, housing prices are tumbling and consumer balance sheets are being repaired.

So if inflation is not an immediate risk, and the economy continues to shrink, isn’t Bernanke doing the right thing by trying to restart the securitization markets?

Opinions vary on this topic. On the one hand, Wall Street’s method of deploying credit appears to be more efficient than conventional (bank) loans because the money is provided by investors who are looking for higher yield rather than bankers tapping into reserves. The problem is that securitization creates incentives for fraud by rewarding loan originators who lend to applicants who have no way of repaying the debt. Unless the system is heavily regulated to insure that traditional lending standards are maintained, speculative bubbles will reemerge and there will be more financial disasters in the future. The former head of the FDIC, William Seidman, anticipated this problem way back in 1993 after cleaning up the S&L crisis. Here’s what he said in his memoirs:

“Instruct regulators to look for the newest fad in the industry and examine it with great care. The next mistake will be a new way to make a loan that will not be repaid.” (Bloomberg)

If regulators had heeded Seidman’s advice, they could have steered the country away from the present calamity.

The problem with an unregulated credit system is that investment banks and hedge funds can skim lavish salaries and bonuses for themselves on the front end before anyone discovers that the loans are fraudulent and the securities worthless. Even so, neither Congress nor the Treasury nor the Fed has taken steps to re-regulate the financial system or to hold any of the main players accountable. It’s “anything goes.” Bernanke has acted as Wall Street’s chief enabler by underwriting shoddy non performing loans, propping up rotten assets with low interest funding, and bailing out investment giants with trillions in taxpayer-backed loans. None of the $12.8 trillion Bernanke has loaned or committed to financial institutions has been approved by Congress. The Fed operates beyond any mandate and outside of any law.

The debate about securitization goes beyond questions about the quality of the underlying loans to focusing on the process itself. Securitization greatly amplifies leverage by repackaging debt into complex instruments. It’s a way of turbo-charging credit expansion. Joseph Stroupe summarizes the issue in a recent Asia Times article:

Remember that there are two fundamental camps with respect to the answer to the question of what lies at the root of the present crisis. One camp holds that America’s new generation of financial assets that resulted from the recently invented financial process known as “securitization” are fundamentally sound in value, and that an over-reaction on the part of investors to the subprime crisis has resulted in a panic-induced collapse in their valuations.

This camp believes that the securitization model can and should be revived, and that when investor confidence is restored in financial assets now seen as “toxic”, then all will be well again, almost magically, as toxic assets become valuable and attractive once again. All that need be done, it is believed, is for the government to work with Wall Street to jump-start securitization, a model this camp vehemently denies has failed, even though many trillions of dollars both spent and committed already have so far failed to get securitization’s heartbeat going again.

The other camp believes that the toxicity is inherent in the very nature of the newly developed financial assets themselves, and that once investors recognized this fact, then that is why their values collapsed. This camp sees the securitization model as fundamentally flawed, based as it is upon artificial inflation of assets, the shortsighted growth of serial asset bubbles created by an unholy de facto alliance of government, big Wall Street banks and credit-rating agencies whose credibility and integrity were profoundly compromised, and unsustainable negative real interest rates (the creation of a massive credit excess), without which the securitization model simply won’t run.

Bernanke says that the securitization markets are “frozen” and that the toxic assets should eventually regain much of their original value. But this is just wishful thinking. Investors aren’t shunning these assets because they’re afraid, but because the banks want too much for them given their implicit riskiness. Stroupe’s analysis is closer to the truth; prices have collapsed because investors recognize the inherent toxicity of the assets themselves. The market isn’t driven by fear, but by common sense. $.30 cents on the dollar is probably all they are worth.

Putting Credit Back Where it Belongs

Do people realize that the reason their home equity is vanishing, their 401ks have been slashed in half and their jobs are at risk is because Wall Street was gaming the system with leverage and financial innovation? The current downturn is not really a recession at all; it’s more like a self-inflicted wound perpetrated by avaricious speculators who put a gun to the economy’s head and blew its brains out. The banks and Wall Street have created a capital hole so vast that the entire economy is being sucked into the abyss. And it all could have been avoided.

Credit production is too important and too lethal to entrust to profit-driven vipers whose only motivation is self-enrichment. The whole system needs rethinking and public input before Bernanke wastes trillions more trying to revive the same crisis-prone business model. If “credit is the economy’s life’s-blood,” as President Obama says, then it should be distributed through a government-controlled public utility. The real lesson of the financial crisis is that privatizing credit has been a disaster.

But the GOP’s problems run deeper than just Bush. The party has become an anachronism: a plodding, dogmatic, self righteous amalgam of disgruntled white zealots who are wildly out-of-step with the times. It’s become irrelevant, and that’s its biggest drawback. The party has lost its Reaganesque glitter and become a rigid, monochromatic “non-party” that no one pays much attention to apart from the occasional zinger on the Daily Show or Letterman. The truth is, the party is just plain dull.

That doesn’t mean the Democrats are any great shakes either. Far from it. In fact, the feckless Dems became Bush’s biggest enablers. In two terms they never stopped Bush once from doing exactly what he wanted, however heinous it might have been.

Wiretapping. Iraq. Torture. Never. The Dems never seemed to grasp that politics is more than just trolling for campaign contributions and preening for the camera. Every once in a while representatives are expected to earn their pay and show some guts. That message is lost on the Democrats.

The Democratic Party is loaded with pompous windbags like Barney Frank and Nancy Pelosi who “talk the talk” but never deliver the goods. Frank has proved over and over again that he’s just lobby fodder for the banking fraternity, faithfully doing their bidding and dressing it up in altruistic mumbo-jumbo. Pelosi’s just as bad. When she’s not applying tooth whitener or getting her hairpiece re-lacquered, she’s busy making sure that anything remotely resembling progressive legislation never reaches the floor of the House.

Yer doin’ a heckuva job, Nancy.

The only thing the Dems have going for them is that they’re not Republicans. They’re not the party that took over all three branches of government and then drove the country off a cliff. That’s how the Republican’s celebrate their victories — mass hara-kiri. In America’s 230-year history, no party has ever crashed and burned so fast or with such fanatical zeal. Republican leaders have been given a permanent roost at FOX News so they can appear from time to time and hurl stones at Obama or hold forth on the evils of illegal immigration. It’s just more of the same polarizing claptrap that keeps them from becoming a serious contender. They’re determined to dig an even bigger hole for themselves by opposing Obama at every turn. What are they thinking? Their ranks are already thinning faster than anyone expected, and now want to duke it out with the most popular president in modern times? No wonder they’re the brunt of every joke on late-night TV. The Republican strategy is tantamount to suicide.

Who Deep-sixed the G.O.P.?

Now that the election is over, the finger pointing has begun and everyone wants to know who’s responsible for destroying the Party. Naturally, the first name that comes to mind is George Bush. But Bush wasn’t as important as people think. He was chosen for the job because his supporters thought they could stitch together another Reagan and because he could be counted on to follow orders without question. But Bush wasn’t steering the ship o state. Not really. The administration was essentially a franchise split up between the three main actors: Cheney, Rumsfeld and Rove. Of those three, it was probably Rove who did the most damage through his backroom maneuvering, his ham-fisted public relations operations and his political arm-twisting. Rove’s bullyboy antics produced a number of short-term triumphs, but they cost the Party dearly in terms of credibility. Just look at the Terry Schiavo fiasco: an emotionally charged issue of personal morality that the administration turned into a circus sideshow. The poor husband was blasted as the devil incarnate for simply carrying out the explicit wishes of his stricken wife.

Michael Schiavo was ripped to shreds by a feral media that had become the propaganda arm of the White House. The incident had “Karl Rove” written all over it.

Eventually Rove’s wheeling and dealing caught up to him and he was forced to step down amidst a barrage of allegations. His scorched earth, “take no prisoners” approach galvanized the base, but alienated decent conservatives who were not comfortable with his win-at-all-cost shenanigans. Ultimately, the party of Lincoln became the party of Rove slipping its ideological moorings and abandoning all claims to moderation. By the time Rove left, the Party was in ruins.

Obama didn’t beat the Republicans. The Republicans beat themselves. It was a self-inflicted wound. The Party had become too ideologically rigid and self destructive. Besides, how much mileage can party get on a platform which only contains two planks: War and tax cuts? That’s not a vision of the future; it’s the fast-track to disaster.

The Republican Party has never been “the party of ideas”; that’s a complete myth. The Republican leadership hates ideas, because ideas mean social programs that divert money from the coffers business tycoons and crooked banksters. Republican ideas are different; they usually involve poking around people’s bedrooms telling them what they can and can’t do or railing against science like evolution or stem cells. The party should lay off ideas altogether and do what they do best; traditional values. Republicans have always been able to sell the notion that America needs to return to some mythic “Golden Age” where Pops ran the corner store and Mom baked cherry pies. That idealized vision resonates with a broad cross-section of the voting public. The Republicans should go back to the things that won them elections and forget the war on immigrants.

The United States has always veered to the right politically, so winning elections shouldn’t be hard for a party that truly represents conservative values. But the Republican Party doesn’t represent conservative values, that’s another myth. In fact, the party isn’t really even pro life. If they were, then Bush would have pushed for anti-abortion legislation when he controlled both houses of congress. But he didn’t, because he knew that if the Republicans put an end to the abortion flap for good, half of their base would have no reason to drag themselves to the polls every two years. Preserving abortion as a permanent issue is all part of a cynical calculation to keep the single-issue fanatics engaged. The Republicans will never end abortion. It’s their meal ticket.

Republicans seem to like their role as minority party; they were never comfortable governing anyway. Besides, wandering aimlessly through the political wilderness has its upside, too. There’s more time for drumming up campaign contributions and appearances on Hannity with the other far-right screwballs. There’s even time to work on that slice and (hopefully) shave a few points off the old golf game. Political parties are like people. They should do what suits their temperament. The Republicans aren’t suited for governing; they had their chance and they made a mess of it. And that’s a good thing, because no one wants another eight years like the last.

Come and see the blood in the streets.
Come and see
the blood in the streets.
Come and see the blood
in the streets!

— Poem by Pablo Neruda

About a month before Barack Obama announced his candidacy for the presidency of the United States, former National Security Adviser Zbigniew Brzezinski appeared on PBS’s Charlie Rose Show and was asked whether he thought Obama would be a good choice for president. Brzezinski paused for a minute, peered at Rose out of the corner of his eye, and answered, “Just think of the symbolism.” As soon as he said that, Brzezinski and Rose broke out into laughter as though they were sharing a private joke.

Brzezinski was right, of course. Obama was the perfect choice for president. Not because of his experience. He had none. He was a two year senator with a resume’ small enough to fit on the back of a matchbox. Still Obama had what Brzezinski and Co. were looking for, symbolism: the kind of symbolism that connected him to people around the world and made them feel like one of their own had finally clawed their way to the top. Even better, Obama was a charismatic populist who could fill stadiums with adoring fans and put a benign face on America’s interventions in Afghanistan and Iraq. What more could Brzezinski hope for? After eight years of dragging “Brand America” through the mud, the country would finally get the emergency facelift it needed and begin to restore its battered image as the world’s indispensable nation.

For leftists, Obama has been a total bust. He’s escalated the war in Afghanistan, increased the cross-border bombings of Pakistan, hemmed and hawed about prosecuting war crimes, refused to actively lobby House members to make it easier for workers to organize (EFCA), and surrounded himself with bank industry reps who’ve committed $12.8 trillion to sinking financial institutions with no assurance that the money would be repaid. Apart from a trifling bill on stem cells, Obama has done absolutely zero to confirm his bone fides as a liberal. The truth is, Obama is neither liberal nor conservative; he’s simply an inspiring orator and a skillful politician who has no strong convictions about anything. If he achieves greatness, it will be because he was thrust into a crisis he couldn’t avoid and reluctantly acted in the best interests of the American people. That possibility still exists, although it seems more unlikely by the day.

Foreign leaders are clearly relieved to see the last of George W. Bush, and they appear to be willing to give Obama every opportunity to mend fences and break with the past. But Obama has made little effort to reciprocate or show that he’s serious about real change. The emphasis seems to be more on public relations than policy. More on glitzy photo ops, grandiose speeches and gadding about from one capital to another, than ending the chronic US meddling and militarism. Where’s the beef or is it all just empty posturing?

No one’s ready to write off Obama just yet, but he needs to show he’s the real deal by taking steps to ratchet down the war machine and reign in the corporate elites and bank vermin. But is it really possible for one man — however well-meaning — to change the course of a nation by standing up to the gaggle of racketeers who pull the strings from behind the curtain? Keep in mind, America’s history of violent interventions, unprovoked wars, color-coded revolutions and coup d’ etats has a long pedigree that stretches from Bunker Hill to Baghdad. That river of blood did not begin with George Bush and it won’t end with Barack Obama. Every generation has produced its own litany of crimes, from Wounded Knee to Nagasaki to My Lai to Falluja. In Harold Pinter’s Nobel acceptance speech, the playwright invokes one such incident that epitomizes the pattern of hostility that has been repeated over and over again wherever the Washington mandarins detect opposition to their iron-fisted rule.

Harold Pinter, Nobel Acceptance Speech:

The United States supported the brutal Somoza dictatorship in Nicaragua for over 40 years. The Nicaraguan people, led by the Sandinistas, overthrew this regime in 1979, a breathtaking popular revolution.

The Sandinistas weren’t perfect. They possessed their fair share of arrogance and their political philosophy contained a number of contradictory elements. But they were intelligent, rational and civilized. They set out to establish a stable, decent, pluralistic society. The death penalty was abolished. Hundreds of thousands of poverty-stricken peasants were brought back from the dead. Over 100,000 families were given title to land. Two thousand schools were built. A quite remarkable literacy campaign reduced illiteracy in the country to less than one seventh. Free education was established and a free health service. Infant mortality was reduced by a third. Polio was eradicated.

The United States denounced these achievements as Marxist/Leninist subversion. In the view of the US government, a dangerous example was being set. If Nicaragua was allowed to establish basic norms of social and economic justice, if it was allowed to raise the standards of health care and education and achieve social unity and national self respect, neighboring countries would ask the same questions and do the same things. There was of course at the time fierce resistance to the status quo in El Salvador.

I spoke earlier about ‘a tapestry of lies’ which surrounds us. President Reagan commonly described Nicaragua as a ‘totalitarian dungeon’. This was taken generally by the media, and certainly by the British government, as accurate and fair comment. But there was in fact no record of death squads under the Sandinista government. There was no record of torture. There was no record of systematic or official military brutality. No priests were ever murdered in Nicaragua. There were in fact three priests in the government, two Jesuits and a Maryknoll missionary. The totalitarian dungeons were actually next door, in El Salvador and Guatemala. The United States had brought down the democratically elected government of Guatemala in 1954 and it is estimated that over 200,000 people had been victims of successive military dictatorships.

Six of the most distinguished Jesuits in the world were viciously murdered at the Central American University in San Salvador in 1989 by a battalion of the Atlacatl regiment trained at Fort Benning, Georgia, USA. That extremely brave man Archbishop Romero was assassinated while saying mass. It is estimated that 75,000 people died. Why were they killed? They were killed because they believed a better life was possible and should be achieved. That belief immediately qualified them as communists. They died because they dared to question the status quo, the endless plateau of poverty, disease, degradation and oppression, which had been their birthright.

The United States finally brought down the Sandinista government. It took some years and considerable resistance but relentless economic persecution and 30,000 dead finally undermined the spirit of the Nicaraguan people. They were exhausted and poverty stricken once again. The casinos moved back into the country. Free health and free education were over. Big business returned with a vengeance. ‘Democracy’ had prevailed.

But this ‘policy’ was by no means restricted to Central America. It was conducted throughout the world. It was never-ending. And it is as if it never happened.

The United States supported and in many cases engendered every right wing military dictatorship in the world after the end of the Second World War. I refer to Indonesia, Greece, Uruguay, Brazil, Paraguay, Haiti, Turkey, the Philippines, Guatemala, El Salvador, and, of course, Chile. The horror the United States inflicted upon Chile in 1973 can never be purged and can never be forgiven.

Hundreds of thousands of deaths took place throughout these countries. Did they take place? And are they in all cases attributable to US foreign policy? The answer is yes they did take place and they are attributable to American foreign policy. But you wouldn’t know it.

Analysis

Pinter’s speech is a somber indictment of US foreign policy; a policy which is now cloaked behind the rock-star facade of Barack Obama. Nothing has changed and, perhaps, nothing will change. The same barbarous campaign that thrived under Bush has been passed along to Obama intact. Wherever there is resistance to US ambitions; there lies the enemy. Whether its Marxists in Bogota, nationalists in Kosovo, Bolivarians in Caracas, Shia militias in Beirut, Islamic moderates in Mogadishu or Quakers in Toledo. They’re all enemies, every one of them, and they need to be dealt with.

Obama is no fool; he knows he’s being used. He knows he wasn’t chosen for his enlightened views on health care and stem cells. He was picked because the men in charge needed a new poster boy to hide behind while they carry out their illicit activities. Obama is not so much of a Commander in chief as he is master illusionist, diverting attention from the stealth war that goes on relentlessly with or without his consent. Here’s Pinter again:

“The crimes of the United States have been systematic, constant, vicious, remorseless, but very few people have actually talked about them. You have to hand it to America. It has exercised a quite clinical manipulation of power worldwide while masquerading as a force for universal good. It’s a brilliant, even witty, highly successful act of hypnosis . . . It’s a scintillating stratagem.”

Consider how the news was shaped to make it look like the invasions of Iraq and Afghanistan were carried out for altruistic reasons. Thus, the war in Afghanistan became “Operation Enduring Freedom,” stressing the selfless generosity of bombing a country into oblivion and reinstating the thuggish warlords to power. The same strategy was used for the invasion of Iraq, which was celebrated as “liberation from a brutal dictator.” Liberation which cost the lives of over 1 million Iraqis and the displacement of 4 million more. Still, no one in the UN or so-called international community has pressed for removing the US from the Security Council or prosecuting its leaders for war crimes. It’s a testimony to the success of the US media in upholding the “tapestry of lies” of which Pinter speaks. Under Obama, the charade has only gotten worse. The coverage of the war has stopped entirely. War? What war? What matters now is Obama’s cheery banter with Jay Leno, or Michelle’s well-proportioned arms or Malia’s adorable Portuguese Waterdog. America is whole again. Let the killing resume.

Pinter:

What has happened to our moral sensibility? Did we ever have any? What do these words mean? Do they refer to a term very rarely employed these days – conscience? A conscience to do not only with our own acts but to do with our shared responsibility in the acts of others? Is all this dead? Look at Guantanamo Bay. Hundreds of people detained without charge for over three years, with no legal representation or due process, technically detained forever. This totally illegitimate structure is maintained in defiance of the Geneva Convention. It is not only tolerated but hardly thought about by what’s called the ‘international community.’ This criminal outrage is being committed by a country, which declares itself to be ‘the leader of the free world’. Do we think about the inhabitants of Guantanamo Bay? What does the media say about them? They pop up occasionally — a small item on page six. They have been consigned to a no man’s land from which indeed they may never return. At present many are on hunger strike, being force-fed, including British residents. No niceties in these force-feeding procedures. No sedative or anesthetic. Just a tube stuck up your nose and into your throat. You vomit blood. This is torture. What has the British Foreign Secretary said about this? Nothing. What has the British Prime Minister said about this? Nothing. Why not? Because the United States has said: to criticize our conduct in Guantanamo Bay constitutes an unfriendly act. You’re either with us or against us.

Obama doesn’t need to solve the world’s problems. He doesn’t have to reverse global warming or slow peak oil, cure AIDS or end world hunger. All he needs to do is meet the minimal requirement of his job as president, which is to deliver justice to his people. That’s why the prosecution of Bush for war crimes is more important than any other issue on the docket. Justice precedes everything; it’s the thread that keeps the social fabric stitched together. Justice for the victims who were killed in their homes with their families while they were sleeping or eating dinner. Justice for the people who were bombed in wedding parties or going to work or at the mosque praying to God. That’s what people want from Obama. Justice, nothing more. The Reverend Martin Luther King said, “The arc of the moral universe is long, but it bends towards justice.” It’s up to Obama follow that arc and take at least one step on the path of legitimacy, accountability and justice.

Pinter:

How many people do you have to kill before you qualify to be described as a mass murderer and a war criminal? One hundred thousand? More than enough, I would have thought. Therefore it is just that Bush and Blair be arraigned before the International Criminal Court of Justice.

It’s highly unlikely that a black man with a background in community organizing really believes that expanding the war in Afghanistan is the right thing to do. Nor is it likely that he supports wiretapping, the crackdown on immigrants, penalizing sellers of medical marijuana, trillion dollar bank bailouts or “enhanced” interrogation. He is merely reading from the script that he has been given. But as the economic crisis deepens and the country becomes more radicalized and politically unstable, that script will have to be tossed aside. Obama will have plenty of opportunities to shrug off his handlers and show what he’s really made of. Perhaps he is great man after all.

Pinter: “When we look into a mirror, we think the image that confronts us is accurate. But move a millimeter and the image changes. We are actually looking at a never-ending range of reflections. But sometimes a writer has to smash the mirror — for it is on the other side of that mirror that the truth stares at us.”

Go ahead, Barack. Smash the mirror.

The housing market is crashing. There are no “green shoots” or “glimmers of hope”; the market is worn to a stump, it’s kaput. Still, whenever new housing figures are released, they’re crunched and tweaked and spin-dried until they tell a totally different story: a hopeful story about an elusive “light in the tunnel.” But there is no light in the tunnel; it’s a myth. The truth is, there’s no sign of a turnaround or a “bottom” in housing at all. Not yet, at least. The real estate market is freefalling and it looks like it’s got a long way to go. So why is the media still peddling the same “rose-colored” claptrap that put the country in this pickle to begin with? Here’s an example of media spin, which appeared in Bloomberg News on Wednesday:

“US home prices rose 0.7 percent in February from the month before, the Federal Housing Finance Agency said in Washington today, a sign that low interest rates may be moderating declines in real estate values. . . . Housing market data indicates prices are starting to “stabilize,” and households’ available cash should improve through each quarter of 2009 and into 2010.” (Bloomberg)

This report is complete gibberish. The only way to get a fix on what’s really happening with housing is to compare prices year over year (yoy) not month to month. Clearly, the journalist decided to spin the story from this angle because it offered the one flimsy sign of hope in a sector that’s been reduced to rubble. But, don’t be fooled, housing isn’t staging a comeback. Not by a long shot.

This is from Marketwatch:

“The Case-Shiller index of 20 major cities fell 2.8% in January, the fastest decline on record. The Case-Shiller index rose more than the Federal Housing Finance Agency (FHFA) index did during the bubble, and it’s fallen faster since the bubble burst . . . The index was down 19% year-over-year in January.”

So, the only reason that housing prices rebounded (slightly) in February was because, one month earlier, they were “declining at the fastest pace on record.” That’s not a sign of “green shoots” like the Pollyannas say. It’s a sign of a ferocious ongoing contraction. The only thing that’s keeping housing from collapsing completely is the Fed’s purchases of Fannie and Freddie mortgage-backed securities (MBS). Bernanke’s action has pushed interest rates to record lows giving homeowners a chance to refinance rather than default on their loans. Struggling homeowners have been granted a one-time reprieve courtesy of the US taxpayer. That’s great, but the fact that the Fed is subsidizing the industry to the tune of $1.25 trillion is hardly cause for celebration. What Bernanke should have done is prevented the credit bubble from inflating in the first place.

Check out this chart on The Big Picture to see a chilling illustration of a market in
capitulation-phase.

As the caption states:

“We are now in uncharted territory — new home starts have never fallen to these levels for as long as the Commerce Department has been tracking this data (since 1959). Note also the magnitude of the drop — it is unprecedented, having easily surpassed the 1982 collapse, the present circumstances have now become slightly worse than the 1973-75 fall.”

Housing will continue to deteriorate no matter what the Fed does; the downward momentum is too great to resist. And although the refi-business is booming, new home sales are still flat. Buyers are just too scared or too broke to take advantage of the ultra-low interest rates. (4.80%, 30-year fixed) And now that Obama’s foreclosure moratorium is over, delinquencies are stacking up faster than ever before auguring another wave of foreclosures. This is from DataQuick: “Golden State Mortgage Defaults Jump to Record High”:

Lenders filed a record number of mortgage default notices against California homeowners during the first three months of this year, the result of the recession and of lenders playing catch-up after a temporary lull in foreclosure activity . . .

A total of 135,431 default notices were sent out during the January- to-March period. That was up 80.0 percent from 75,230 for the prior quarter and up 19.0 percent from 113,809 in first quarter 2008, according to MDA DataQuick.

And from Bloomberg:

Fannie Mae and Freddie Mac mortgage delinquencies among the most creditworthy homeowners rose 50 percent in a month as borrowers said drops in income or too much debt caused them to fall behind, according to data from federal regulators.

The number of so-called prime borrowers at least 60 days behind on mortgages owned or guaranteed by the companies rose to 743,686 in January, from 497,131 in December, and is almost double the total for October, the Federal Housing Finance Agency said in a report to Congress today.

So, even top-of-the-line prime borrowers are having trouble making their payments. The debt virus has now spread to all loan categories. But what about Obama’s mortgage relief program? Won’t that help keep people in their homes?

In the last two months, roughly 9,000 mortgage modifications have been worked out under Obama’s Streamlined Modification Program. At the same time delinquencies have increased by roughly 195,000 per month. That means there are 186,000 more delinquencies than modifications per month. Obama’s program is like a re-staging of grunting Sisyphus pushing his boulder up the hill — utter futility.

Many economists believe that “cramdowns” are the only way to slow the rate of foreclosures and stop the precipitous decline in housing prices. Cramdowns allow a judge to modify mortgages by marking down the face value (the principle) of the loan. When mortgages accurately reflect current market prices, people tend to stay in their homes. But when prices fall sharply and homeowners owe more on their mortgage than their home is worth, (negative equity) they simply stop making their payments and leave.

So far, cramdown legislation has passed the House, but has stalled in the Senate where it looks like it will be defeated. Powerful groups of bondholders have taken their case to Capital Hill where they’re waging a pitch battle against the Obama plan. At this point, it doesn’t look good for supporters of debt relief even though cramdowns are desperately needed to stop the hemorrhaging of foreclosures.

As we noted in an earlier article, the backlog of homes on the market is still in the vicinity of 10 months. But that excludes the vast “shadow inventory” the banks are keeping off the market. According to SF Gate:

Lenders nationwide are sitting on hundreds of thousands of foreclosed homes that they have not resold or listed for sale, according to numerous data sources. And foreclosures, which banks unload at fire-sale prices, are a major factor driving home values down.

“We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market,” said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. “California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You’d have further depreciation and carnage. (”Banks aren’t Selling Many Foreclosed Homes,” SF Gate)

Inventory has dropped from its peak in 2008, but if the estimates of the shadow inventory are accurate, then the backlog of vacant homes is still about the same. Any recovery in housing will show up first as falling inventory, since the heart of the problem is oversupply.

On Wednesday, the New York Times reported that fewer people are moving because of the troubles in housing. In fact, “Fewer Americans moved in 2008 than in any year since 1962, according to census data released Wednesday, and immigration from overseas was the lowest in more than a decade. . . . It shows that the U.S. population, often thought of as the most mobile in the developed world, seems to have been stopped dead in its tracks due to a confluence of constraints posed by a tough economic spell.” (Sam Roberts, “As housing Market Dips, more in US are Staying Put,” New York Times)

Diminished mobility is just another of the unpleasant side effects of the housing bust.

The problem with housing goes far beyond the supply/demand imbalance. True, buyers are staying away because they know that prices could fall another 15 to 20 percent, but there’s more to it than just that. The housing crisis has been a shock to the psyche. The dream of home ownership — which is so closely linked to the so-called American dream — has turned into a nightmare. The trauma of watching one’s life savings and retirement vanish in a matter of months is devastating. It’s not an experience that’s easily forgotten. Naturally, people will be more skeptical in the future about seductive interest rates and other faux inducements. Keep in mind, that after investors were burned for $7 trillion in the dot.com swindle, tech stocks swooned and the NASDAQ plunged 80 percent over the next year and a half. Housing is headed down that same bumpy path. There probably won’t be an uptick in housing until the market is flat on its back and given up for dead.

New Home Sales Update: On Friday, stocks skyrocketed on news that “new home sales did not fall as far as expected.” Once again, the story was presented in a way that suggested the housing market is “stabilizing”. But a closer examination of Friday’s data reveals how the media has manipulated the facts to create the impression that things are getting better. But they are not getting better; they’re getting worse. Here is a summary of Friday’s “good news”:

1) The median price of a new home fell $201,400 year over year (YOY)

2) Sales of new homes were down 31 percent from March 2008. They reached a record 1.389 million in July 2005.

3) Distressed properties accounted for about 50 percent of all sales.

4) Inventory (new homes) is still bulging at 10.7 months

5) Foreclosures are at record highs

Bernanke has provided generous “100 cents on the dollar” loans for Triple A mortgage-backed collateral that is now worth 30 cents on the dollar. The Fed stands to lose trillions of dollars on these loans because the assets will never regain their original value. Eventually the taxpayer will have to pony up the difference in higher taxes, fewer public services and a weaker dollar.

Bernanke’s liquidity injections may have sparked a flurry of speculation, but they won’t end the recession or slow the downward spiral. The relentless system-wide contraction continues apace and all of the leading economic indicators point to a deepening slump that will last for two years or more. Here’s a clip from a recent statement from the IMF:

Recessions associated with financial crises have typically been severe and protracted. Financial crises typically follow periods of rapid expansion in lending and strong increases in asset prices. Recoveries from these recessions are often held back by weak private demand and credit reflecting, in part, households’ attempts to increase saving rates to restore balance sheets. They are typically led by improvements in net trade, following exchange rate depreciations and falls in unit costs.

Globally synchronized recessions are longer and deeper than others. Excluding the present, there have been three episodes since 1960 during which 10 or more of the 21 advanced economies in the sample were in recession at the same time: 1975, 1980 and 1992 . . . Recoveries are usually sluggish, owing to weak external demand.

The recession will be a long uphill slog regardless of developments in the stock market. Bernanke admitted as much last Thursday when he said that the collapse of U.S. lending will cause “long-lasting” damage to home prices, household wealth and borrowers’ credit scores:

“One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be. . . . The damage from this turn in the credit cycle — in terms of lost wealth, lost homes, and blemished credit histories — is likely to be long-lasting.”

Unlike Treasury Secretary Geithner, Bernanke has been surprisingly candid in his analysis of the crisis. That doesn’t mean that his policies have been worker-friendly. Far from it. But he has been a lot more honest about the shortcomings of deregulation and financial innovation. So far, the meltdown has wiped out more than $11 trillion of household wealth, sent unemployment skyrocketing, and pushed millions of people from their homes. As Bernanke admits, the country will not quickly bounce back.

Economists Kenneth Rogoff and Carmen Reinhart have conducted a study on the last 18 international financial crises and compiled their findings in a document called “Is the 2007 U.S. Subprime Financial Crisis So Different?” What they discovered was that “rising public debt is a near universal precursor of other post-war crises” and that countries that experienced large capital inflows were particularly vulnerable to crises. By 2006, two-thirds of the world’s surplus capital was flowing into the United States via its current account deficit. This flood of foreign capital kept interest rates low, housing and equity prices high, and Wall Street flush with money. Now foreign investment is drying up, housing prices are falling, the secondary market is frozen, and deflation is setting in across all sectors of the economy.

Rogoff and Reinhart believe that “recessions that follow in the wake of big financial crises tend to last far longer than normal downturns, and to cause considerably more damage. If the United States follows the norm of recent crises, as it has until now, output may take four years to return to its pre-crisis level. Unemployment will continue to rise for three more years, reaching 11–12 percent in 2011.” (Kenneth Rogoff and Carmen Reinhart, “Don’t Buy the Chirpy Forecasts,” Newsweek)

The proliferation of opaque, unregulated debt-instruments (MBSs, CDOs, CDSs) also played a big role in the present crash by reducing transparency and increasing systemic instability. Here’s Rogoff and Reinhart:

Assuming the U.S. continues going down the tracks of past financial crises, perhaps the scariest prospect is the likely evolution of public debt, which tends to soar in the aftermath of a crisis. A base-line forecast, using the benchmark of recent past crises, suggests that U.S. national debt will rise by $8.5 trillion over the next three years. Debt rises for a variety of reasons, including bailout costs and fiscal stimulus. But the No. 1 factor is the collapse in tax revenues that inevitably accompanies a deep recession.

Tax revenues are already falling sharply across the country as the recession deepens. In fact, Bloomberg News reports that, “State and local sales-tax revenue fell more sharply in the fourth quarter of 2008 than at any time in the past half century . . . ” (Corporate and personal income taxes are also declining at a record pace.) That makes it impossible to predict the ultimate cost of the crisis. But what makes it even harder is that Treasury Secretary Timothy Geithner refuses to remove toxic assets from the banks balance sheets using the usual “tried and true” methods. A recent report from a congressional oversight committee (The Warren Report) revealed that there are three ways to fix the banking system: liquidation, reorganization and subsidization. Geithner has rejected all three of these preferring to implement his own makeshift Public Private Investment Program (PPIP), which is thoroughly untested, has no base of public or political support, and is clearly designed to shift the toxic debts of the banks onto the taxpayer through publicly-funded non recourse loans. (Geithner’s plan will allow the banks to establish off-balance sheet operations so they can buy their own bad assets from themselves using 94 per cent public money) The whole thing is an obvious swindle papered over with gibberish.

So far, less than $10 billion has been transacted through Geithner’s PPIP, a mere drop in the bucket. The IMF estimates that the banks and other financial institutions may be holding up to $4 trillion in toxic assets. At the current rate, Geithner’s strategy will take a century to succeed. The Treasury Secretary knows his plan won’t fix the banking system; he’s just hoping that the economy rebounds before the government is forced to nationalize the big banks. It’s just a stalling ploy, but even so, there are risks. As the economy worsens, the likelihood of another financial meltdown or a run on the dollar increases. Foreign central banks and investors are getting restless and want to see the Treasury take positive steps to fix the system. In recent months, China has slowed its purchases of US Treasuries, traded tens of billions of USD in currency swaps, and has gone on a spending spree for raw materials — all to protect itself from weakness in the dollar. According to Bloomberg:

“People’s Bank of China Zhou Xiaochuan called for the establishment of a “super-sovereign reserve currency” last month after Chinese Premier Wen Jiabao said he’s worried a weaker US dollar may hurt China’s investments. Inflation and a depreciating dollar would erode the value of US holdings owned by international investors.”

Again, Bloomberg:

“China, Japan and Korea should establish a routine mechanism to diversify the region’s reserve currencies away from the dollar, the China Securities Journal reported, citing central bank adviser Fan Gang. The Asian countries need to consider setting up a transitional arrangement to help reduce reliance on the dollar before the problems in the international financial system are resolved.”

Geithner’s foot dragging could be extremely costly for America’s long-term economic prospects. The Treasury Secretary should be tackling the toxic assets problem head-on and stop the dilly-dallying; there’s no time to lose.

According to the Organization for Economic Co-operation and Development (OECD), “The world economy is in the midst of its deepest and most synchronized recession in our lifetimes, caused by a global financial crisis and deepened by a collapse in world trade.”

The vicious contraction has spread to every sector without exception — industrial output, credit, private consumption, exports, retail, residential investment, housing, equities prices and manufacturing — all have seen sharp cutbacks or plunging revenues. The spurious notion that “green shoots” are beginning to sprout up, is just more happy talk to divert attention from the severity of the impending storm.

The Fed is in way over its head and Bernanke knows it. Nothing is working — not the zero-percent interest rates, nor the multi-trillion dollar lending facilities, nor monetizing the debt by purchasing long-term Treasuries. It’s all been a flop. Financial institutions are deleveraging, businesses are slashing inventory, and corporations are laying off workers in droves. More than 40 percent of the credit that was sloshing around the economy via low interest loans has dried up. The banks aren’t lending and Wall Street’s credit-generating contraption — securitization — has broken down bursting the humongous equity bubble and precipitating a sudden decline in economic activity. There are no quick fixes. It will take years to reassemble the broken pieces or design a new financial architecture. It’s the end of an era.

As for housing; the situation is devolving beyond anyone’s wildest expectations. It’s not a Depression, it’s bigger and more savage — an Uber-Depression! Take a look at this chart from Barry Ritholtz’s The Big Picture.

We are in uncharted water in a leaky boat.

Housing is a millstone that’s dragging down the whole economy. The Wall Street bulls can enjoy their “sucker’s rally” for now, but it’s going to be short-lived. The fundamentals have never been this bad. It’s like a chapter from Revelation. The banks are padding their earnings reports with accounting trickery to hide their losses. The consumer is underwater and worried about losing his job or getting evicted from his home. And the government is trying to conceal the damage to the financial system through trillion dollar stealth bailouts that never get congressional approval. It’s a real mess, and the problem is that there’s just too much debt. Martin Wolf of the Financial Times summed it up like this last Monday:

Consider the salient example of the US, on whose final demand so much has for so long depended. Total private sector debt rose from 112 per cent of GDP in 1976 to 295 per cent at the end of 2008. Financial sector debt alone jumped from 16 per cent to 121 per cent of GDP over this period. How much of a reduction in these measures of leverage occurred in the crisis year of 2008? None. On the contrary, leverage rose still further.

The danger is that a turnround, however shallow, will convince the world things are soon going to be the way they were before. They will not be. It will merely show that collapse does not last forever once substantial stimulus is applied. The brutal truth is that the financial system is still far from healthy, the deleveraging of the private sectors of highly indebted countries has not begun, the needed rebalancing of global demand has barely even started and, for all these reasons, a return to sustained, private-sector-led growth probably remains a long way in the future. (Martin Wolf, “Why the ‘green shoots’ of recovery could yet wither, Financial Times)

Debt is at the very center of the current financial crisis. The massive debt-overhang can only be resolved by writing down losses, restructuring capital, and initiating debt-relief programs. The Fed and Treasury’s task is to soften the effects of a hard landing not to stop the process altogether. That would be pointless. Recessions are a necessary purgative that cleanse the system of waste and excess. Wall Street’s unprecedented credit expansion — which ballooned to gigantic proportions from fetid assets, off-balance sheet operations and mega-leveraging — ensures that this recession will be more agonizing than any before. But that just makes it all the more important. The system has to exhale before the patient can be revived.

In March, housing prices accelerated on the downside indicating bigger adjustments dead ahead. Trend lines are steeper now than ever before — nearly perpendicular. Housing prices are not falling, they’re crashing and crashing hard. Now that the foreclosure moratorium has ended, Notices of Default (NOD) have spiked to an all-time high. These Notices will turn into foreclosures in 4 to 5 months time creating another cascade of foreclosures. Market analysts predict there will be 5 MILLION MORE FORECLOSURES BETWEEN NOW AND 2011. It’s a disaster bigger than Katrina. Soaring unemployment and rising foreclosures ensure that hundreds of banks and financial institutions will be forced into bankruptcy. 40 percent of delinquent homeowners have already vacated their homes. There’s nothing Obama can do to make them stay. Worse still, only 30 percent of foreclosures have been relisted for sale suggesting more hanky-panky at the banks. Where have the houses gone? Have they simply vanished?

600,000 “Disappeared Homes”?

Here’s an excerpt from the SF Gate explaining the mystery:

Lenders nationwide are sitting on hundreds of thousands of foreclosed homes that they have not resold or listed for sale, according to numerous data sources. And foreclosures, which banks unload at fire-sale prices, are a major factor driving home values down.

“We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market,” said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. “California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You’d have further depreciation and carnage.”

In a recent study, RealtyTrac compared its database of bank-repossessed homes to MLS listings of for-sale homes in four states, including California. It found a significant disparity — only 30 percent of the foreclosures were listed for sale in the Multiple Listing Service. The remainder is known in the industry as “shadow inventory.” (”Banks aren’t Selling Many Foreclosed Homes,” SF Gate)

If regulators were deployed to the banks that are keeping foreclosed homes off the market, they would probably find that the banks are actually servicing the mortgages on a monthly basis to conceal the extent of their losses. They’d also find that the banks are trying to keep housing prices artificially high to avoid heftier losses that would put them out of business. One thing is certain, 600,000 “disappeared” homes means that housing prices have a lot farther to fall and that an even larger segment of the banking system is underwater.

Here is more on the story from Mr. Mortgage, “California Foreclosures About to Soar…Again”:

Are you ready to see the future? Ten’s of thousands of foreclosures are only 1-5 months away from hitting that will take total foreclosure counts back to all-time highs. This will flood an already beaten-bloody real estate market with even more supply just in time for the Spring/Summer home selling season . . . Foreclosure start (NOD) and Trustee Sale (NTS) notices are going out at levels not seen since mid 2008. Once an NTS goes out, the property is taken to the courthouse and auctioned within 21-45 days….The bottom line is that there is a massive wave of actual foreclosures that will hit beginning in April that can’t be stopped without a national moratorium.

JP Morgan Chase, Wells Fargo and Fannie Mae have all stepped up their foreclosure activity in recent weeks. Delinquencies have skyrocketed foreshadowing more price-slashing into the foreseeable future. According to the Wall Street Journal:

“Ronald Temple, co-director of research at Lazard Asset Management, expects home prices to fall 22% to 27% from their January levels. More than 2.1 million homes will be lost this year because borrowers can’t meet their loan payments, up from about 1.7 million in 2008.” (Ruth Simon, “The housing crisis is about to take center stage once again,” Wall Street Journal)

Another 20 percent carved off the aggregate value of US housing means another $4 trillion loss to homeowners. That means smaller retirement savings, less discretionary spending, and lower living standards. The next leg down in housing will be excruciating; every sector will feel the pain. Obama’s $75 billion mortgage rescue plan is a mere pittance; it won’t reduce the principle on mortgages and it won’t stop the bleeding. Policymakers have decided they’ve done enough and are refusing to help. They don’t see the tsunami looming in front of them plain as day. The housing market is going under and it’s going to drag a good part of the broader economy along with it. Stocks, too.

Conditions in the broader economy are now vastly different than those on Wall Street, where the S&P 500 and the Dow Jones Industrials have rallied for 5 weeks straight regaining more than 25 percent of earlier losses. Fed chief Ben Bernanke’s $13 trillion in monetary stimulus has triggered a rebound in the stock market while Main Street continues to languish on life-support waiting for Obama’s $787 billion fiscal stimulus to kick in and compensate for falling demand and rising unemployment. The rally on Wall Street indicates that Bernanke’s flood of liquidity is creating a bubble in stocks since present values do not reflect underlying conditions in the economy. The fundamentals haven’t been this bad since the 1930s.

The financial media is abuzz with talk of a recovery as equities inch their way higher every week. CNBC’s Jim Cramer, the hyperventilating ringleader of “Fast Money”, announced last week, “I am pronouncing the depression is over.” Cramer and his clatter of media cheerleaders ignore the fact that every sector of the financial system is now propped up with Fed loans and T-Bills without which the fictive free market would collapse in a heap. For 19 months, Bernanke has kept a steady stream of liquidity flowing from the vault at the US Treasury to the NYSE in downtown Manhattan. The Fed has recapitalized financial institutions via its low interest rates, its multi-trillion dollar lending facilities, and its direct purchase of US sovereign debt and Fannie Mae mortgage-backed securities. (Monetization) The Fed’s balance sheet has become a dumping ground for all manner of toxic waste and putrid debt-instruments for which there is no active market. When foreign central banks and investors realize that US currency is backed by dodgy subprime collateral; there will be a run on the dollar followed by a stampede out of US equities. Even so, Bernanke assures his critics that “the foundations of our economy are strong”.

As for the recovery, market analyst Edward Harrison sums it up like this:

This is a fake recovery because the underlying systemic issues in the financial sector are being papered over through various mechanisms designed to surreptitiously recapitalize banks while monetary and fiscal stimulus induces a rebound before many banks’ inherent insolvency becomes a problem. This means the banking system will remain weak even after recovery takes hold. The likely result of the weak system will be a relapse into a depression-like circumstances once the temporary salve of stimulus has worn off. Note that this does not preclude stocks from large rallies or a new bull market from forming because as unsustainable as the recovery may be, it will be a recovery nonetheless.¹

The rally in the stock market will not fix the banking system, slow the crash in housing, patch-together tattered household balance sheets, repair failing industries or reverse the precipitous decline in consumer confidence. The rising stock market merely indicates that profit-driven speculators are back in business taking advantage of the Fed’s lavish capital injections which are propelling equities into the stratosphere. Meanwhile, the unemployment lines continue to swell, the food banks continue to run dry and the homeless shelters continue to burst at the seams. So far, $12 trillion has been pumped into the financial system while less than $450 billion fiscal stimulus has gone to the “real” economy where workers are struggling just to keep food on the table. The Fed’s priorities are directed at the investor class not the average working Joe. Bernanke is trying to keep Wall Street happy by goosing asset values with cheap capital, but the increases to the money supply are putting more downward pressure on the dollar. The Fed chief has also begun purchasing US Treasuries, which is the equivalent of writing a check to oneself to cover an overdraft in one’s own account. This is the kind of gibberish that passes as sound economic policy. The Fed is incapable if fixing the problem because the Fed is the problem.

Last week, the market shot up on news that Wells Fargo’s first quarter net income rose 50 percent to $3 billion pushing the stock up 30 percent in one session. The financial media celebrated the triumph in typical manner by congratulating everyone on set and announcing that a market “bottom” had been reached . The news on Wells Fargo was repeated ad nauseam for two days even though everyone knows that the big banks are holding hundreds of billions in mortgage-backed assets which are marked way above their true value and that gigantic losses are forthcoming. Naturally, the skeptics were kept off-camera or lambasted by toothy anchors as doomsayers and Cassandras. Regrettably, creative accounting and media spin can only work for so long. Eventually the banks will have to write down their losses and raise more capital. Wells Fargo slipped the noose this time, but next time might not be so lucky. Here’s how Bloomberg sums up Wells’ situation:

Wells Fargo & Co., the second biggest U.S. home lender, may need $50 billion to pay back the federal government and cover loan losses as the economic slump deepens, according to KBW Inc.’s Frederick Cannon.

KBW expects $120 billion of “stress” losses at Wells Fargo, assuming the recession continues through the first quarter of 2010 and unemployment reaches 12 percent, Cannon wrote today in a report. The San Francisco-based bank may need to raise $25 billion on top of the $25 billion it owes the U.S. Treasury for the industry bailout plan, he wrote. …

Details were scarce and we believe that much of the positive news in the preliminary results had to do with merger accounting, revised accounting standards and mortgage default moratoriums, rather than underlying trends,” wrote Cannon, who downgraded the shares to “underperform” from “market perform.” “We expect earnings and capital to be under pressure due to continued economic weakness.”

What happened to all those nonperforming loans and garbage MBS? Did they simply vanish into the New York ether? Could Wells sudden good fortune have something to do with the recent FASB changes to accounting guidelines on “mark to market” which allow banks greater flexibility in assigning a value to their assets? Also, Judging by the charts on the Internet, Wells appears to have the smallest “ratio of loan loss reserves” of the four biggest banks. That’s hardly reassuring.

Paul Krugman takes an equally skeptical view of the Wells report:

About those great numbers from Wells Fargo…remember, reported profits aren’t a hard number; they involve a lot of assumptions. And at least some analysts are saying that the Wells assumptions about loan losses look, um, odd. Maybe, maybe not; but you do have to say that it would be awfully convenient for banks to sound the all clear right now, just when the question of how tough the Obama administration will really get is hanging in the balance.

The banks are all playing the same game of hide-n-seek, trying to hoodwink the public into thinking they are in a stronger capital position than they really are. It’s just more Wall Street chicanery papered over with vapid media propaganda. The giant brokerage houses and the financial media are two spokes on the same wheel gliding along in perfect harmony. Unfortunately, media fanfare and massaging the numbers won’t pull the economy out of its downward spiral or bring about a long-term recovery. That will take fiscal policy, jobs programs, debt relief, mortgage writedowns and a progressive plan to rebuild the nation’s economy on a solid foundation of productivity and regular wage increases. So far, the Obama administration has focused all its attention and resources on the financial system rather than working people. That won’t fix the problem.

Deflation has latched on to the economy like a pitbull on a porkchop. Food and fuel prices fell in March by 0.1 percent while unemployment continued its slide towards 10 percent. Wholesale prices fell by the most in the last 12 months since 1950. According to MarketWatch, “Industrial production is down 13.3% since the recession began in December 2007, the largest percentage decline since the end of World War II”….The capacity utilization rate for total industry fell further to 69.3 percent, a historical low for this series, which begins in 1967.” (Federal Reserve) The persistent fall in housing prices (30 percent) and losses in home equity only add to deflationary pressures. The wind is exiting the humongous credit bubble in one great gust.

Obama’s $787 billion stimulus is too small to take up the slack in a $14 trillion per year economy where manufacturing and industrial capacity have slipped to record lows and unemployment is rising at 650,000 per month. High unemployment is lethal to an economy where consumer spending is 72 percent of GDP. Without debt relief and mortgage cram-downs, consumption will sputter and corporate profits will continue to shrink. S&P 500 companies have already seen a 37 percent drop in corporate profits. Unless the underlying issues of debt relief and wages are dealt with, the present trends will persist. Growth is impossible when workers are broke and can’t afford to buy the things the make.

The stimulus must be increased to a size where it can do boost economic activity and create enough jobs to get over the hump. Yale economics professor Robert Schiller makes the case for more stimulus in his Bloomberg commentary on Tuesday:

In the Great Depression … the U.S. government had a great deal of trouble maintaining its commitment to economic stimulus. ‘Pump- priming’ was talked about and tried, but not consistently. The Depression could have been mostly prevented, but wasn’t…. In the face of a similar Depression-era psychology today, we are in need of massive pump-priming again.

It would be a shame if we are so overwhelmed by anger at the unfairness of it all that we do not take the positive measures needed to restore us to full employment. That would not just be unfair to the U.S. taxpayer. That would be unfair to those who are living in Hoovervilles…; it would be unfair to those who are being evicted from their homes, and can’t find new ones because they can’t find jobs. That would be unfair to those who have to drop out of school because they, or their parents, can’t find jobs.

It is time to face up to what needs to be done. The sticker shock involved will be large, but the costs in terms of lost output of not meeting either the credit target or the aggregate demand target will be yet larger.”²

Even though industrial production, manufacturing, retail and housing are in free-fall, the talk on Wall Street still focuses on the elusive recovery. The S&P 500 touched bottom at 666 on March 6 and has since retraced its steps to 852. Clearly, Bernanke’s market-distorting capital injections have played a major role in the turnabout. Former Secretary of Labor under Bill Clinton and economics professor at University of Cal. Berkeley, Robert Reich, explains it like this on his blog-site:

All of these pieces of upbeat news are connected by one fact: the flood of money the Fed has been releasing into the economy…. So much money is sloshing around the economy that its price is bound to drop. And cheap money is bound to induce some borrowing. The real question is whether this means an economic turnaround. The answer is it doesn’t.

Cheap money, you may remember, got us into this mess. Six years ago, the Fed (Alan Greenspan et al) lowered interest rates to 1 percent…. The large lenders did exactly what they could be expected to do with free money — get as much of it as possible and then lent it out to anyone who could stand up straight (and many who couldn’t). With no regulators looking over their shoulders, they got away with the financial equivalent of murder.

The only economic fundamental that’s changed since then is that so many people got so badly burned that the trust necessary for consumers, investors, and businesses to repeat what they did then has vanished… yes, some consumers will refinance and use the extra money they extract from their homes to spend again. But most will use the extra money to pay off debt and start saving again, as they did years ago….

I admire cockeyed optimism, and I understand why Wall Street and its spokespeople want to see a return of the bull market. Hell, everyone with a stock portfolio wants to see it grow again. But wishing for something is different from getting it. And cockeyed optimism can wreak enormous damage on an economy. Haven’t we already learned this?³

If the purpose of Bernanke’s grand economics experiment was to create uneven inflation in the equities markets and, thus, widen the chasm between the financials and the real economy; he seems to have succeeded. But for how long? How long will it be before foreign banks and investors realize that the Fed’s innocuous-sounding “lending facilities” have released a wave of low interest speculative liquidity into the capital markets? How else does one explain soaring stocks when industrial capacity, manufacturing, exports, corporate profits, retail and every other sector have been pounded into rubble? Liquidity is never inert. It navigates the financial system like mercury in water darting elusively to the area which offers the greatest opportunity for profit. That’s why the surge popped up first in the stock market. (so far) When it spills into commodities–and oil and food prices rise–Bernanke will realize his plan has backfired..

Bernanke’s financial rescue plan is a disaster. He should have spent a little less time with Milton Friedman and a little more with Karl Marx. It was Marx who uncovered the root of all financial crises. He summed it up like this:

The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit.”⁴

Bingo. Message to Bernanke: Workers need debt-relief and a raise in pay not bigger bailouts for chiseling fatcat banksters

1. Edward Harrison, “The Fake Recovery,” Credit Writedowns
2. Robert Schiller, “Depression Lurks unless there’s more Stimulus,”Bloomberg
3. Robert Reich’s Blog, “Why We’re Not at the Beginning of the End, and Probably Not Even At the End of the Beginning“
4. Karl Marx, Capital, vol. 3, New York International publishers, 1967; Thanks to Monthly review, John Bellamy Foster

Goldman Sachs is attempting to shut down a dissident blogger who is extremely critical of the investment bank, its board members and its practices. The bank has instructed Wall Street law firm Chadbourne & Parke to pursue blogger Mike Morgan, warning him in a recent cease-and-desist letter that he may face legal action if he does not close down his website.

According to Chadbourne & Parke’s letter, dated April 8, the bank is rattled because the site “violates several of Goldman Sachs’ intellectual property rights” and also “implies a relationship” with the bank itself.

Unsurprisingly for a man who has conjoined the bank’s name with the Number of the Beast — although he jokingly points out that 666 was also the S&P500’s bear-market bottom — Mr. Morgan is unlikely to go down without a fight. He claims he has followed all legal requirements to own and operate the website — and that the header of the site clearly states that the content has not been approved by the bank.

On a special section of his blog entitled “Goldman Sachs vs Mike Morgan” he predicts that the fight will probably end up in court.

“It’s just another example of how a bully like Goldman Sachs tries to throw their weight around,” he writes.

Morgan agreed to answer a few questions about Goldman Sachs, the TARP and the ongoing financial crisis.

Mike Whitney: Is Goldman Sachs trying to shut down your web site?

Mike Morgan: Yes

MW: Why?

Morgan: The legal answer to that would be . . . you need to ask them the question. I would think it is because we are exposing the truth . . . and the truth hurts.

MW: Have you libeled them or published privileged information?

Mike Morgan: No.

MW: Could you tell us something about yourself so that readers can trust your criticism of G-Sax?

Morgan: I am 53 years old and believe all of the answers for how we should live are in the Bible . . . . God gave David the choice of paying the consequences at the hands of David’s enemies or at the hand of God. David chose God’s consequences. Hank Paulson and the thousands of wicked men like him deserve the wrath of the millions of lives they have destroyed. We must go after the crooks and make them pay the consequences for their greed and the total disregard for anyone other than themselves. We need to start with Hank Paulson, who as CEO of Goldman Sachs, was more responsible than any 10 men combined, for the violent Depression we are about to enter.

MW: Why was G-Sax given $10 billion out of the TARP funds before federal regulators checked their books to see if they were solvent?

Morgan: Because King Henry (Henry Paulson) said so. As former CEO of Goldman Sachs, the last thing he wanted to see was a collapse of Goldman Sachs. And as Treasury Secretary with a big stick, he could do whatever he pleased . . . and he did.

MW: It was widely believed that most of the five biggest investment banks were leveraged 30-to-1. If that’s the case, then G-Sax probably would not have survived the downturn in the market without government assistance. Do you agree with this analysis?

Morgan: I agree.

MW: After Bear Stearns and Lehman Bros. defaulted, Merrill Lynch quickly sold out to Bank of America.

Morgan: Merrill was being run by John Thain, the former Goldman Sachs executive that helped Hank Paulson force out Jon Corzine who at the time was c-CEO with Paulson.

MW: That left Goldman Sachs and Morgan Stanley as the next likely candidates to be taken down by short sellers.

Morgan: Short sellers are not the issue. If short sellers drive down a stock below market value, then it becomes an opportunity for anyone that thinks the stock is a buy to bury the shorts.

MW: This is when SEC chief Christopher Cox — who had never intervened in the market prior to this — put emergency rules in place to stop the short selling of financial institutions. What was Cox’s action all about?

Morgan: The SEC is toothless and I still don’t know why Cox is not in jail. He not only looked the other way on the Madoff issue, but since he left, the SEC has gone after more than a dozen scams. Are you going to tell me everything was fine three months ago on Chrissy Cox’s watch? No, but I can tell you there is much more to this story….As for the SEC and short sellers, that was King Henry. Period. Full Stop.

MW: Was this mainly an attempt by Washington elites to pull G-Sax’s bacon out of the fire?

Morgan: Goldman Sachs and other companies affiliated with Goldman Sachs. Kinda like the old MCI Friends and Family Program.

MW: Recently it was revealed that G-Sax had been paid more than $12 billion for credit default swaps (CDS) it held with insurance giant AIG. Financial institutions that buy these CDS know that they are accepting additional risk because they are unregulated and outside government oversight. That said, Treasury’s payoff to G-Sax on these CDS was equivalent to paying off a gambler’s losses at the racetrack. Why was G-Sax compensated for their CDS? Why was it kept secret; and who authorized it?

Morgan: King Henry and his loyal lieutenant Neil Kashkari. Most people don’t realize, Neil Kashkari was King Henry’s lieutenant at Goldman Sachs. Neil is 35 years old with little experience other than being a very private executive assistant to King Henry when he was CEO of Goldman. Let’s ask ourselves . . . why exactly is Kashkari still on the job? Easy answer . . . because our President and Chris Dodd were both bought with Goldman Sachs’ money. These two men have received more money from Wall Street than any politician in the history of the United States. By the way, Obama was only around for two years, while Dodd was there for more than a decade. Obama received more money from Wall Street in two years than Dodd did in a decade.

MW: What is the nature of the relationship between G-Sax and the political establishment in Washington?

Morgan: If I answered that question I would need to increase the thickness of my Kevlar body suit.

MW: Why is Treasury a revolving door for investment bankers that are tied to Wall Street?

Morgan: Because the American public allows it. Benjamin Franklin said . . . Well done is better than well said. Too many Americans gripe and moan, but when it comes time to doing anything . . . they sit back on the couch with a bag of chips and the TV. We think it is cute to use the TV to amuse our toddlers. Do you think it is any different for 75 per cent of the American public?

MW: Are special interest groups dictating policy in the Obama White House?

Morgan: I can’t count that high. But if you just look at Wall Street and where the money came from, you will realize that Barack Hussein Obama is nothing more than a puppet of Wall Street.

MW: In an article that appeared in The Atlantic Monthly, a former chief economist of the IMF, Simon Johnson, had this to say:

“The crash has laid bare many unpleasant truths about the United States… recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression we’re running out of time.”

Do you agree with Johnson that banks have a stranglehold on the political process and that “we are running out of time”? If so, how do we go about removing these people from office and replacing them with people who will operate in the public’s interest?

Morgan: First, I think guys like Simon Johnson are the guys that should be running the show. Simon along with William Black, Elizabeth Warren and Ron Paul. There are more, but if we had that trio at the helm, we’d be moving to a world of light, instead of a world of deep, violent darkness.

As to your question about how to remove these people from office, I believe it will be very violent . . . and very well deserved. We are two Biblical generations removed from the Great Depression of 1929. In 1969 we had race riots. We lost a true leader when we lost Martin Luther King, and the country paid the consequences. Here we are 40 years later . . . a Biblical generation, as we enter what I believe will be a period of violence beginning this summer. When you can’t feed your kids, and the folks at Goldman Sachs are sitting around the pool sipping cocktails and munching on snacks . . . that’s when those without go after those with.

The problem now is very simply . . . companies like Goldman Sachs created a financial system that was double stacked. One, they skimmed trillions of dollars out of our pension fund and other fiduciary money under their management. Two, like drug dealers they provided very creative financing to hundreds of millions of people around the world . . . which those folks can no longer afford to pay back. But the boys and girls and Goldman Sachs have already walked off with the money, leaving the people that bought the debt with little more than a piece of paper . . . and those that owe the debt, with the inability to ever pay it back.

MW: Will you fight Goldman in court?

Morgan: Yes. I’m prepared to fight them with several attorneys and law professors that are anxious to take this one on. I hope they do press the issue in court, but I kinda doubt it.

“With this report, the Congressional Oversight Panel examines Treasury’s current strategy and evaluates the progress it has achieved thus far. This report returns the Panel’s inquiry to a central question raised in its first report: What is Treasury’s strategy?”

Six months and $1 trillion later, and Congress still cannot figure out what Geithner is up to. It’s a wonder the Treasury Secretary hasn’t been fired already.

From the report:

“In addition to drawing on the $700 billion allocated to Treasury under the Emergency Economic Stabilization Act (EESA), economic stabilization efforts have depended heavily on the use of the Federal Reserve Board’s balance sheet. This approach has permitted Treasury to leverage TARP funds well beyond the funds appropriated by Congress. Thus, while Treasury has spent or committed $590.4 billion of TARP funds, according to Panel estimates, the Federal Reserve Board has expanded its balance sheet by more than $1.5 trillion in loans and purchases of government-sponsored enterprise (GSE) securities. The total value of all direct spending, loans and guarantees provided to date in conjunction with the federal government’s financial stability efforts (including those of the Federal Deposit Insurance Corporation (FDIC) as well as Treasury and the Federal Reserve Board) now exceeds $4 trillion.”

So, while Congress approved a mere $700 billion in emergency funding for the TARP, Geithner and Bernanke deftly sidestepped the public opposition to more bailouts and shoveled another $3.3 trillion through the back door via loans and leverage for crappy mortgage paper that will never regain its value. Additionally, the Fed has made a deal with Treasury that when the financial crisis finally subsides, Treasury will assume the Fed’s obligations vis-à-vis the “lending facilities”, which means the taxpayer will then be responsible for unknown trillions in withering investments.

From the report:

“To deal with a troubled financial system, three fundamentally different policy alternatives are possible: liquidation, receivership, or subsidization. To place these alternatives in context, the report evaluates historical and contemporary efforts to confront financial crises and their relative success. The Panel focused on six historical experiences: (1) the U.S. Depression of the 1930s; (2) the bank run on and subsequent government seizure of Continental Illinois in 1984; (3) the savings and loan crisis of the late 1980s and establishment of the Resolution Trust Corporation; (4) the recapitalization of the FDIC bank insurance fund in 1991; (5) Sweden’s financial crisis of the early 1990s; and (6) what has become known as Japan’s “Lost Decade” of the 1990s. The report also surveys the approaches currently employed by Iceland, Ireland, the United Kingdom, and other European countries.”

This statement shows that the congressional committee understands that Geithner’s lunatic plan has no historic precedent and no prospect of succeeding. Geithner’s circuitous Public-Private Investment Program (PPIP) — which is designed to remove toxic assets from bank balance sheets — is an end-run around “tried-and-true” methods for fixing the banking system. In the most restrained and diplomatic language, Warren is telling Geithner that she knows that he’s up to no good.

From the report:

“Liquidation avoids the uncertainty and open-ended commitment that accompany subsidization. It can restore market confidence in the surviving banks, and it can potentially accelerate recovery by offering decisive and clear statements about the government’s evaluation of financial conditions and institutions.”

The committee agrees with the vast majority of reputable economists who think the banks should be taken over (liquidated) and the bad assets put up for auction. This is the committee’s number one recommendation.

The committee also explores the pros and cons of conservatorship (which entails a reorganization in which bad assets are removed, failed managers are replaced, and parts of the business are spun off) and government subsidization, which involves capital infusions or the purchasing of troubled assets. Subsidization, however, carries the risk of distorting the market (by keeping assets artificially high) and creating a constant drain on government resources. Subsidization tends to create hobbled banks that continue to languish as wards of the state.

Liquidation, conservatorship and government subsidization; these are the three ways to fix the banking system. There is no fourth way. Geithner’s plan is not a plan at all; it’s mumbo-jumbo dignified with an acronym, PPIP. The Treasury Secretary is being as opaque as possible to stall for time while he diverts trillions in public revenue to his scamster friends at the big banks through capital injections and nutty-sounding money laundering programs like the PPIP.

From the report:

“Treasury’s approach fails to acknowledge the depth of the current downturn and the degree to which the low valuation of troubled assets accurately reflects their worth. The actions undertaken by Treasury, the Federal Reserve Board and the FDIC are unprecedented. But if the economic crisis is deeper than anticipated, it is possible that Treasury will need to take very different actions in order to restore financial stability.”

This is a crucial point; the toxic assets are not going to regain their value because their current market price — 30 cents on the dollar for AAA mortgage-backed securities — accurately reflects the amount of risk they bear. The market is right and Geithner is wrong; it’s that simple. Many of these securities are comprised of loans that were issued to people without sufficient income to make the payments. These “liar’s loans” were bundled together with good loans into mortgage-backed securities. No one can say with any certainty what they are really worth. Naturally, there is a premium for uncertainty, which is why the assets are fetching a mere 30 cents on the dollar. This won’t change no matter how much Geithner tries to prop up the market. The well has been already poisoned.

Also, according to this month’s Case-Schiller report, housing prices are falling at the fastest pace since their peak in 2006. That means that the market for mortgage-backed securities (MBS) will continue to plunge and the losses at the banks will continue to grow. The IMF recently increased its estimate of how much toxic mortgage-backed paper the banks are holding to $4 trillion.

The banking system is underwater and needs to be resolved quickly before another Lehman-type crisis arises sending the economy into a protracted Depression. Geithner is clearly the wrong man for the job. His PPIP is nothing more than a stealth rip-off of public funds which uses confusing rules and guidelines to conceal the true objective, which is to shift toxic garbage onto the public’s balance sheet while recapitalizing bankrupt financial institutions.

So, why is Geithner being kept on at Treasury when his plan has already been thoroughly discredited and his only goal is to bailout the banks through underhanded means?

That question was best answered by the former chief economist of the IMF, Simon Johnson, in an article which appeared in The Atlantic Monthly:

The crash has laid bare many unpleasant truths about the United States. One of the most alarming … is that the finance industry has effectively captured our government — a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation; recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression we’re running out of time.(The Atlantic Monthly, May 2009)

The banks have a stranglehold on the political process. Many of their foot soldiers now occupy the highest offices in government. It’s up to people like Elizabeth Warren to draw attention to the silent coup that has taken place and do whatever needs to be done to purge the moneylenders from the seat of power and restore representative government. It’s a tall order and time is running out.

* See Elizabeth Warren’s 8-minute video summary of the COP report.

The deteriorating economic conditions have taken their toll on consumer confidence and forced businesses to lay off employees that won’t be needed during the slowdown. The system is bursting with overcapacity. Demand is falling faster than any time since the 1930s. Inventories will have to be trimmed and budgets cut to muddle through the down-times. Foreign trade has slowed to a crawl, auto sales are down by 40 percent or more, and unemployment is rising at 650,000 per month. Policymakers have pushed through a $800 billion stimulus plan, but it won’t be nearly enough to stop the steady rise in unemployment or take up the slack in an economy where industrial output has been cut in half, new home construction has dropped to record lows, and manufacturing has fallen off a cliff. Economists warn that when governments don’t step in and provide stimulus to increase aggregate demand, consumers cut back sharply on spending and push the economy deeper into depression.

Treasury Secretary Geithner and Fed chief Bernanke have lent or committed $13 trillion trying to keep the financial system functioning, but they’ve only managed to plug a few holes and avoid a system-wide collapse. The financial system is hobbled and unable to provide sufficient credit to generate growth. Every sector has suffered cutbacks, layoffs and slimmer profits. The problems go beyond toxic assets or complex derivatives. The system is plagued with stagnation, overcapacity and redundancy. Economics professor Robert Brenner sums it up like this in an interview in the Asia Pacific Journal:

Robert Brenner: “The current crisis is more serious than the worst previous recession of the postwar period, between 1979 and 1982, and could conceivably come to rival the Great Depression, though there is no way of really knowing. Economic forecasters have underestimated how bad it is because they have over-estimated the strength of the real economy and failed to take into account the extent of its dependence upon a buildup of debt that relied on asset price bubbles. In the U.S., during the recent business cycle of the years 2001-2007, GDP growth was by far the slowest of the postwar epoch. There was no increase in private sector employment. The increase in plants and equipment was about a third of the previous, a postwar low. Real wages were basically flat. There was no increase in median family income for the first time since World War II. Economic growth was driven entirely by personal consumption and residential investment, made possible by easy credit and rising house prices. Economic performance was weak, even despite the enormous stimulus from the housing bubble and the Bush administration’s huge federal deficits. Housing by itself accounted for almost one-third of the growth of GDP and close to half of the increase in employment in the years 2001-2005. It was, therefore, to be expected that when the housing bubble burst, consumption and residential investment would fall, and the economy would plunge. ”¹

The economy is now in a downward spiral. Tightening in the credit markets has made it harder for consumers to borrow or businesses to expand. Overextended financial institutions are forced to shed assets at firesale prices to meet margin calls from the banks. Asset deflation is ongoing with no end in sight. Price declines in housing have reached 30 percent already and are now accelerating on the downside. This is the nightmare scenario that Bernanke hoped to avoid; a capitulation in real estate that drags the rest of economy into a black hole. Economist Nouriel Roubini and market analyst Meredith Whitney predict that housing prices will drop another 20 percent before they hit bottom. Nearly half of all homeowners will be underwater and owe more on their mortgages than the current value of their homes. That will increase the foreclosures and push scores of banks into default. According to Merrill Lynch’s economist David Rosenberg:

It would take over three years to achieve price stability (in housing) The problem is that prices do not begin to stabilize until we break below eight months’ supply – and they tend to deflate 3% per quarter until that happens. So as impressive as it is that the builders have taken single-family starts below underlying sales, their efforts are just not sufficient to prevent real estate prices from falling further. In fact, even if the builders were to declare a moratorium immediately, that is, taking starts to zero, demand is so weak and the unsold inventory so intractable that it would now take over three years to achieve the holy grail of price stability in the residential real estate market.

The main economic indicators all point to a long period of retrenchment ahead. The slowdown in global trade has hit Germany, Japan, and most of Asia particularly hard. The export-driven model of growth has suffered a major setback and won’t rebound for some time to come. With the US consumer unable to continue his debt-fueled spending spree, surplus countries will have to develop domestic markets for growth, but it won’t be easy. Chinese workers save 50 percent of what they earn and German workers already have a comfortable life without increasing personal consumption. Higher wages and lower interest rates can help stimulate demand, but cultural influences make it difficult to change spending habits. Meanwhile, the economy will continue to languish operating well below its optimum capacity.

Capital flows have also suddenly reversed causing turmoil in the currency markets. January’s TIC data indicates that net capital outflows for the US were negative $148 billion in January. Capital is now fleeing the country. Financial protectionism has triggered the repatriation of foreign investment causing a sharp drop in the purchase of US sovereign debt. This is from Brad Setser, economist for the CFR:

The obvious implication of the recent downturn in total reserve holdings — and the $180 billion fall in q4 wasn’t driven by currency moves — is that the pace of growth in the world’s dollar reserves has slowed dramatically…

The obvious implication: most of the 2009 US fiscal deficit WILL NEED TO BE FINANCED DOMESTICALLY. The Fed’s custodial data indicates central banks are still buying Treasuries, though at a somewhat slower pace than in late 2008. But their demand hasn’t kept up with issuance.²

The United States does not have the reserves to finance it own massive deficits which will soar to $1.9 trillion by the end of 2009. The Fed will have to increase its purchases of US Treasuries and monetize the debt. Foreign holders of Treasuries and dollar-backed assets ($5 trillion overseas) will be watching carefully as Bernanke revs up the printing presses to fight the recession and meet government obligations. China, Russia, Venezuela and Iran have already called for a change in the world’s reserve currency. It won’t happen overnight, but the momentum is steadily growing.

The S&P 500 has soared 23 percent in the last four weeks, but the current bear market rally is misleading. The prospects for a quick recovery are remote at best. The fundamentals are all weak. Corporate profits are down, GDP is negative 6 percent, housing is in a shambles, and the banking system broken. The Fed has increased the money supply by 22 percent, but economic activity is at a standstill. The velocity at which money is spent is the slowest since 1987. Nothing is moving. The banks are hoarding, credit has dried up, and consumers are saving for the first time in 2 decades. The banks’ credit-conduit cannot function properly until bad assets are removed from their balance sheets. But the magnitude of the losses make it impossible for the government to purchase them outright without bankrupting the country. According to the Times Online, the IMF has increased its estimates of how much toxic mortgage-backed paper the banks are holding:

“Toxic debts racked up by banks and insurers could spiral to $4 trillion, new forecasts from the International Monetary Fund (IMF) are set to suggest.

The IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia.

Banks and insurers, which so far have owned up to $1.29 trillion in toxic assets, are facing increasing losses as the deepening recession takes a toll, adding to the debts racked up from sub-prime mortgages. The IMF’s new forecast, which could be revised again before the end of the month, will come as a blow to governments that have already pumped billions into the banking system.”

Since banks lend at a ratio of 10 to 1; the amount of credit cut off to the broader economy will ensure that sluggish growth well into the future. If there is a recovery, it will be weak. The Obama administration will have to increase its capital injections even though they will add to mushrooming deficits. So far, financial institutions have only written down $1 trillion or 25 percent of their losses. This means the banking system is insolvent. Eventually, Obama will have to resolve the bad banks and auction off troubled assets, even though political support is rapidly eroding. According to political analyst F. William Engdahl, most of the garbage assets are concentrated in the nation’s five biggest banks:

Today five US banks according to data in the just-released Federal Office of Comptroller of the Currency’s Quarterly Report on Bank Trading and Derivatives Activity, hold 96% of all US bank derivatives positions in terms of nominal values, and an eye-popping 81% of the total net credit risk exposure in event of default.

The five are, in declining order of importance: JPMorgan Chase which holds a staggering $88 trillion in derivatives (€66 trillion!). Morgan Chase is followed by Bank of America with $38 trillion in derivatives, and Citibank with $32 trillion. Number four in the derivatives sweepstakes is Goldman Sachs with a ‘mere’ $30 trillion in derivatives. Number five, the merged Wells Fargo-Wachovia Bank, drops dramatically in size to $5 trillion. Number six, Britain’s HSBC Bank USA has $3.7 trillion.³

These five banking Goliaths are at the center of political power in America today. Their White House emissary, Timothy Geithner, has concocted a rescue plan–the Public-Private Investment Program–which will provide 94 percent funding from the FDIC for the purchase bad assets. The program is designed to keep asset prices artificially high while transferring the bulk of the losses to the taxpayer. The plan has been widely criticized and has even raised a few eyebrows even among usually-supportive members of the establishment like the Financial Times:

US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JP Morgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.

The plans proved controversial, with critics charging that the government’s public-private partnership — which provide generous loans to investors — are intended to help banks sell, rather than acquire, troubled securities and loans.

Banks have three options if they want to buy toxic assets: apply to become one of four or five fund managers that will purchase troubled securities; bid for packages of bad loans; or buy into funds set up by others. The government plan does not allow banks to buy their own assets, but there is no ban on the purchase of securities and loans sold by others.⁴

It’s a multi-billion dollar shell game with myriad opportunities for fraud. In theory, the banks could create their own off-balance sheet operations (SIVs or SPEs) and use them to purchase their own bad assets taking advantage of the government’s 94 percent low interest non recourse loans. It’s a blatant swindle and another windfall for Wall Street.

Geithner’s plan does not fix the problems with the banks, it only delays the final outcome. The next leg-down in the recession will push many of the undercapitalized banks into receivership. Geithner’s PPIP won’t change that. As housing prices fall and foreclosures rise, the capital position of many of the banks will become untenable leading to a rash of bank failures. An article in Monday’s Wall Street Journal puts adds some historical perspective to today’s financial crisis:

The events of the past 10 years have an eerie similarity to the period leading up to the Great Depression. Total mortgage debt outstanding increased from $9.35 billion in 1920 to $29.44 billion in 1929. In 1920, residential mortgage debt was 10.2% of household wealth; by 1929, it was 27.2% of household wealth….

The causes of the Great Depression need more study, but the claims that losses on stock-market speculation and a monetary contraction caused the decline of the banking system both seem inadequate. It appears that both the Great Depression and the current crisis had their origins in excessive consumer debt — especially mortgage debt — that was transmitted into the financial sector during a sharp downturn.

Why does one crash cause minimal damage to the financial system, so that the economy can pick itself up quickly, while another crash leaves a devastated financial sector in the wreckage? The hypothesis we propose is that a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end of the wealth and income distribution, can be transmitted quickly and forcefully into the financial system. It appears that we’re witnessing the second great consumer debt crash, the end of a massive consumption binge.⁵

PARTY LIKE IT’S 1929

Two leading economic historians, Barry Eichengreen and Kevin H. Rourke, have written an article “A Tale of Two Depressions” which has been widely circulated on the Internet. It illustrates (with graphs) how the global economy is plummeting faster now than during the 1930s.

By nearly every objective standard, the present downturn is worse than the Great Depression. Manufacturing, industrial production, foreign trade, capital flows, consumer confidence, housing, and even stocks are falling faster today than after the crash of 1929. So far, Bernanke’s monetary bandaids have prevented the wholesale collapse of the financial system, but that could change. The economy continues its downhill slide and it looks like there’s nothing to stop it from falling further still.

1. ”Overproduction not Financial Collapse is the Heart of the Crisis,” Robert P. Brenner speaks with Jeong Seong-jin, Asia Pacific Journal
2. ”Foreign Central banks aren’t going to finance much of the 2009 US fiscal deficit; Their reserves aren’t growing anymore,” Brad Setser, Council on Foreign Relations
3. ”Geithner’s ‘Dirty Little Secret’: The Entire Global Financial System is at Risk“, F. William Engdahl, Global Research
4. The Financial Times
5. ”From Bubble to Depression?” Steven Gjerstad and Vernon L. Smith, Wall Street Journal