Winding Up Bear Stearns: Paulson’s Gift to His Bankster Buddies

One picture tells the whole story. It’s a photo of five grim looking men in gray suits staring ahead blankly like they were in the dock with Saddam awaiting sentencing. Every one of them looks downcast and dejected; shoulders rounded and jaws set. This is what desperation looks like, which is why the photo was kept off the front pages of the leading newspapers.

The group took no questions and, as far as the media was concerned, the meeting never happened. But it did happen; and it happened on Monday at the White House at 2 PM. That’s when President Bush convened the Working Group on Financial Markets, also known as the Plunge Protection Team, to explain their strategy for dealing with deteriorating conditions in the financial markets. The details of the meeting remain unknown, but judging by the sudden (and irrational) recovery in the stock market on Tuesday; their plan must have succeeded.

The Plunge Protection Team is a panel that includes Fed Chairman Ben Bernankee, Treasury Secretary Henry Paulson, Securities and Exchange Commission Chairman Christopher Cox, and acting Commodity Futures Trading Commission head Walter Lukken. According to John Crudele of the New York Post, the Plunge Protection Team’s (PPT) objective is to redirect the stock market by “buying market averages in the futures market, thus stabilizing the market as a whole.” In the event of a terrorist attack or a natural disaster, the group’s activities could play an extremely positive role in saving the market from an unnecessary meltdown. However, direct intervention into supposedly “free markets” is less defensible when it is merely a matter of saving an over-leveraged banking system from its inevitable Day of Reckoning. And, yet, that appears to be the reason for the White House confab; to buy a little more time before the final explosion.

The psychology behind the PPT’s activities is explained in greater detail by Robert McHugh Ph.D. who provides a description of how it works in his essay “The Plunge Protection Team Indicator”:

The PPT decides markets need intervention, a decline needs to be stopped, or the risks associated with political events that could be perceived by markets as highly negative and cause a decline, need to be prevented by a rally already in flight. To get that rally, the PPT’s key component — the Fed — lends money to surrogates who will take that fresh electronically printed cash and buy markets through some large unknown buyer’s account. That buying comes out of the blue at a time when short interest is high. The unexpected rally strikes blood, and fear overcomes those who were betting the market would drop. These shorts need to cover, need to buy the very stocks they had agreed to sell (without owning them) at today’s prices in anticipation they could buy them in the future at much lower prices and pocket the difference. Seeing those stocks rally above their committed selling price, the shorts are forced to buy — and buy they do. Thus, those most pessimistic about the equity market end up buying equities like mad, fueling the rally that the PPT started. Bingo, a huge turnaround rally is well underway, and sidelines money from Hedge Funds, Mutual funds and individuals’ rushes in to join in the buying madness for several days and weeks as the rally gathers a life of its own.1

The powers of the PPT are greatly exaggerated; eventually the liquidity they provide has to be drained from the system. The popular myth that the Fed simply creates as much money as it chooses and spreads it around like confetti; is pure rubbish. The Fed has very definite balance constraints. The system is not quite as rigged as many people imagine. According to Bloomberg News, the Fed has already depleted most of its resources:

“The Fed has committed as much as 60 percent of the $709 billion in Treasury securities on its balance sheet to providing liquidity and opened the door to more with yesterday’s decision to become a lender of last resort for the biggest Wall Street dealers.”2

The troubles in the credit markets and real estate are bigger than the Fed or the PPT; and they know it. The next step is massive government intervention; mortgage-rate freezes, bailouts and fiscal stimulus. Big government is back; Reaganism has gone full-circle. That doesn’t mean that the PPT cannot have an important psychological affect in soothing jittery markets or stalling a system-wide collapse. It just means, that markets will eventually correct regardless of what anyone does to stop them. The sharp downturn in the financial markets is the result of unsustainable credit expansion that can’t be fixed by the parlor tricks of the PPT. The rate at which financial institutions are deleveraging and destroying capital will inevitably trigger an economic crisis equal to the Great Depression. What is needed is strong leadership and a re-commitment to transparency, not “more of the same” low interest crack and financial hanky-panky. It’s time to come clean with the public and admit we have a problem.

“Sucker rallies”, like Tuesday’s 400 point surge on Wall Street just helps to conceal the deeply rooted problems that need to be addressed before investor confidence can be restored. Blogger Rick Ackerman summed it up succinctly in his entry:

These psychotic, 400-point rallies in the Dow do not augur renewed confidence. They are being driven almost entirely by short-covering, and even the otherwise clueless news anchors are starting to dismiss them as meaningless. One of these days, moments after the last surviving bear’s short position has been liquidated, stocks are going to fall so steeply that even the Plunge Protection Team will call for back-up. Then, the financial collapse that so many have been expecting will unfold in just a few days, with enough power to leave the global economy in ruins for a generation.”3

Whether Ackerman’s dire predictions materialize or not, there’s no denying that the situation is getting worse by the day. In the last week alone, two major financial institutions, Carlyle Capital and Bear Stearns have either gone under or been bailed out wiping out tens of billions in market capitalization. These flameouts have increased the rate of the deflation adding to the already prodigious losses from housing foreclosures, delinquent credit card debt, defaulting car loans, and the deleveraging in the hedge fund industry. Fortress America has sprung a leak, and capital is escaping in a torrent.

“One thing is for certain, we’re in challenging times,” Bush opined on Monday after meeting with his top economic aides. “But we are on top of the situation.”

That’s comforting. Bush is all over it.

Tuesday’s 75 basis point rate cut by the Fed is another sign of desperation. The Fed Funds rate is now 2 percentage points below the rate of inflation; a obvious attempt on Bernanke to reflate the equity bubble at the expense of the dollar. Is that why Wall Street was so jubilant; another savage blow to the currency?

The Fed’s statement was as bleak as any they have ever released sounding more like passages from the Book of the Dead than minutes of the Federal Open Market Committee:

Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

Inflation has been elevated, and some indicators of inflation expectations have risen … uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully.

Today’s policy action … should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain.

Wall Street rallied on the cheery news.

Also, on Tuesday, the battered investment banks began posting first quarter earnings which turned out to be better than expected. Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. beat estimates which added to the stock market giddiness. Unfortunately, a careful reading of the reports, shows that things are not quite as they seem. The jubilation is unwarranted; it’s just more smoke and mirrors.

“Lehman Brothers Holdings Inc. reported a 57% drop in fiscal first-quarter net income amid weakness in its fixed-income business, though results topped analysts’ expectations.”4

The same was true of financial giant Goldman Sachs:

Goldman Sachs Group Inc.’s fiscal first-quarter net income dropped 53% on $2 billion in losses on residential mortgages, credit products and investments …The biggest Wall Street investment bank by market value reported net income of $1.51 billion, or $3.23 a share, for the quarter ended Feb. 29, compared to $3.2 billion, or $6.67 a share, a year earlier…. Results included $1 billion in losses on residential mortgage loans and securities, and nearly $1 billion in losses on credit products and investment losses …5

The bottom line is that both companies first quarter earnings dropped by more than a half in just one year alone while, at the same time, they booked heavy losses. That’s hardly a reason for celebration. The major investment banks remain on the critical list because of the billions of dollars of toxic debt they still carry on their balance sheets. Consider industry leader Goldman Sachs, for example, which is sitting on a backlog of bad paper from the subprime/securitization debacle as well as an unknown amount of LBOs (Leveraged buyouts) and commercial real estate deals (CREs) that are heading south fast. Market analyst, Mark Gongloff, sheds a bit of light on the real condition of the big financials in his article “Crunch Proves A Test of Faith For Street Strong”:

All of the brokerage houses are highly leveraged, with a high ratio of assets to shareholders’ equity, a sign they have used debt heavily to build up positions in hope of greater returns. Morgan Stanley, which will report Wednesday, had a leverage ratio of 32.6-to-1 at the end of last year, nearly as high as Bear’s 32.8-to-1. Lehman was leveraged 30.7-to-1, and Merrill Lynch 27.8-to-1. And the would-be rock, Goldman? It was leveraged 26.2-to-1.”6

Remember, Carlyle Capital was leveraged 32 to 1 ($22 billion equity) and went “poof” in a matter of days when it couldn’t scrape together a measly $400 million for a margin call. How vulnerable are these other maxed-out players now that the credit bubble has popped and the whole system is quickly unwinding?

Not very safe, at all. As Gongloff points out:

“Based in part on numbers reported at the end of Bear’s fourth quarter, estimated that Bear Stearns had $35 billion in liquid assets and borrowing capacity, enough to operate for 20 months. Turns out it had enough for three days.”

That’s right; three days and it was over. Why would anyone think it will be different with these other equally-exposed banks? These institutions are basically insolvent now. The Federal Reserve is just trying to prop them up to maintain appearances. But it’s a hopeless cause. As hyper-inflated assets are downgraded; structured investments and arcane hedges against default will continue to disintegrate and these profligate institutions will be crushed by a stampede of panicking investors. The flight to safety has already begun. Cash is king.

Look what has transpired just since Monday.

“Crude oil, copper and coffee led the biggest decline ever in commodities on speculation that a U.S. recession will stall demand for raw materials.”7 All asset classes fall in a deflationary spiral, even commodities which many people thought would be spared. Not so. In fact, even gold has begun to retreat as hedge funds and other market participants are forced to relinquish their positions.

In other news, Reuters reports:

The yield on U.S. 3-month Treasury bills fell below 1 percent on Monday to levels not seen in 50 years prompted by intense safety bids for cash spurred by the ongoing global credit crunch… Investors were pulling money out of stocks and even the booming commodity market even after the Federal Reserve conducted a fresh round of measures over the weekend to alleviate the credit crisis.8

Here’s another example of the “flight to safety” as investors recognize the warning signs of deflation. This trend is likely to intensify even though the Fed will continue to cut rates and real earnings on Treasuries will go negative. In another report from Reuters:

The Chicago Board Options Exchange Volatility Index or VIX on Monday surged to its highest level in nearly two months as a fire sale of Bear Stearns and an emergency Federal Reserve cut in the discount rate reignited credit fears.Doris Frankel, “UPDATE 2-VIX vaults over 30 at fresh 5-year highs,” Reuters, 17 March 2008.

Fear is higher now than it has been in a long time. Option traders are loading up on index puts in the Standard & Poor’s 500 index. The “Fear Gage, as it is called, is soaring to new heights as credit problems continue to mount and business begins to slow to a crawl.

And, perhaps most important of all:

The cost of borrowing in dollars overnight rose by the most in at least seven years after the Federal Reserve’s emergency cut in the discount interest rate stoked concern that credit losses are deepening…. The London interbank offered rate, or Libor climbed 81 basis points to 3.86 percent, the British Bankers’ Association said today. It was the biggest increase since at least January 2001. The comparable pound rate rose 28 basis points to 5.59 percent, the largest gain since Dec. 31, 2007.9

This may sound like technical gibberish geared for market junkies, but it is critical for understanding the gravity of what is really going on. The Fed’s rate cuts are not normalizing the lending between banks. In fact, the situation is actually deteriorating quite quickly. When banks don’t lend to each other (because they are worried about getting their money back) the wheels of capitalism grind to a halt. The banks are the essential conduit for providing credit to the broader economy. If there’s a slowdown in traffic, economic growth begins to slow immediately. Presently, the banks are hoarding cash to cover the losses on their mortgage-backed investments and to shore up their skimpy capital reserves. As a result, consumer spending is sluggish and GDP is beginning to shrink.

“We know we’re in a sharp (decline), and there’s no doubt that the American people know that the economy has turned down sharply”, said Henry Paulson on NBC television on Sunday. “There’s turbulence in our capital markets and it’s been going on since August. We’re looking for ways to work our way through it.”

No kidding. But Paulson is clearly out of his depth. He’s simply not the man to deal with a crisis of this magnitude. His only concern is bailing out his rich friends in the banking industry. The interests of workers and consumers are just brushed aside. Has anyone from the Dept of the Treasury (or the Fed) suggested a bailout for the 14,000 Bear Stearns employees who just lost not only their jobs but the entire retirement when the company was purchased by JP Morgan?

Of course, not. Because both Paulson and Bernanke take a class oriented approach to the problem that narrows their range of vision and limits their ability to pose viable remedies. They are unable to see the whole playing field. For example, Bernanke assumes that if he keeps cutting rates, he can reflate the equity bubble by stimulating consumer spending. But that is not going happen. First of all, the banks are not passing on the savings to customers. And, second, the banks are only lending to applicants with a flawless credit history. In other words, the Fed’s cuts may be good for Bernanke and Paulson’s buddies, but they do nothing for either the consumer or the broader economy. Also, as Michael Hudson notes in his latest article the banks are taking the money they borrow from the Fed and investing it elsewhere:

This week the Fed tried to reverse the plunge in asset prices by flooding the banking system with $200 billion of credit. Banks were allowed to turn their bad mortgage loans and other loans over to the Federal Reserve at par value (rather at just 20% “mark to market” prices). The Fed’s cover story is that this infusion will enable the banks to resume lending to “get the economy moving again.” But the banks are using the money to bet against the dollar. They are borrowing from the Fed at a low interest rate, and buying foreign euro-denominated bonds yielding a higher interest rate–and in the process, making a currency gain as the euro rises against dollar-denominated assets. The Fed thus is subsidizing capital flight, exacerbating inflation by making the price of imports (headed by oil and other raw materials) more expensive. These commodities are not more expensive to European buyers, but only to buyers paying in depreciated dollars.10

The banksters are “buying foreign euro-denominated bonds” during an economic crisis in America? Whoa. Now there’s an interesting take on patriotism.

The Fed’s strategy has even failed to lower mortgage rates which are pinned to the 30-year Treasury and which has actually gone up since Bernanke began slashing rates. This inability to pass on the Fed’s rate cuts to potential mortgage applicants ensures that the housing meltdown will continue unabated well into 2009 and, perhaps, 2010.

In the last few days, the Fed has provided $30 billion to buy up the least-liquid speculative debts of a privately-owned investment bank, Bear Stearns, which was leveraged at 32 to 1 and which will remain unsupervised by federal regulators. How does that address the underlying issues of the credit crunch? Are Bernanke and Paulson really trying to put the financial markets back on solid footing again or are they merely expressing their bank-centered bias?

That question was answered in an article on Tuesday in the Wall Street Journal which explained the real reasons behind the Bear bailout:

The illusion was shattered Saturday morning, when Mr. Paulson was deluged by calls to his home from bank chief executives. They told him they worried the run on Bear would spread to other financial institutions. After several such calls, Mr. Paulson realized the Fed and Treasury had to get the J.P. Morgan deal done before the markets in Asia opened on late Sunday, New York time.

‘It was just clear that this franchise was going to unravel if the deal wasn’t done by the end of the weekend,’ Mr. Paulson said in an interview yesterday.11

So all it took was a little nudge from his banking cohorts for Paulson to swing into action and firm up the deal. That says it all. The interests of the American people were never even considered. It was all choreographed to bail out the financial industry. No wonder so many people believe that the Federal Reserve and the US Treasury are merely an extension of the banking establishment. The Bear bailout proves it.

  1. Robert McHugh Ph.D., “The Plunge Protection Team Indicator,” Financial Sense.” []
  2. Scott Lanman and Rich Miller, “Bernanke May Run Low on Ammunition for Loans, Rates,” Bloomberg. []
  3. Rik’s Piks Rick Ackerman. []
  4. Wall Street Journal. []
  5. Dow Jones Newswire, “UPDATE: Goldman Sachs FY1Q Net Down 53% Amid Write-Downs,” CNNMoney.com, 18 March 2008. []
  6. “Crunch Proves A Test of Faith For Street Strong,” Wall Street Journal. []
  7. Claudia Carpenter and Millie Munshi, “Commodities Head for Record Decline on Slowing Growth (Update2),” Bloomberg, 17 March 2008. []
  8. Richard Leong, “UPDATE 1-U.S. 3-month bill yield seen lowest in 50 years,” Reuters, 17 March 2008. []
  9. Sandra Hernandez and Daniel Kruger, “Treasuries Rise; 3-Month Bill Rates Fall to Lowest Since 1950s,”Bloomberg, 17 March 2008. []
  10. Save the Economy, Dismantle the Empire,” CounterPunch, 15-16 March 2008. []
  11. “The Week that Shook Wall Street,” Wall Street Journal. []
Mike Whitney lives in Washington state. He can be reached at: fergiewhitney@msn.com. Read other articles by Mike.

18 comments on this article so far ...

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  1. Don Hawkins said on March 24th, 2008 at 5:33am #

    http://www.columbia.edu/~jeh1/2008/TargetCO2_20080317.pdf
    This is James Hansen and many more that I am very sure is being read at the highest levels. The sooner we all know we can get started on this.

  2. messianicdruid said on March 24th, 2008 at 6:29am #

    Owe no man anything but to love him. The borrower is the servant of the lender. If it is a sin {1John3:4} to collect usury, it is a sin to pay it.

  3. hp said on March 24th, 2008 at 1:03pm #

    You don’t become famous for no reason.

  4. Don Hawkins said on March 24th, 2008 at 5:37pm #

    http://www.columbia.edu/~jeh1/mailings/20080324_Rampant.pdf
    James Hansen just put this out a few hours ago.

  5. D.R. Munro said on March 25th, 2008 at 5:03am #

    “The banksters are “buying foreign euro-denominated bonds” during an economic crisis in America? Whoa. Now there’s an interesting take on patriotism. ”

    Only serves to prove what I’ve been contending all along. Any “patriot” is a fool who has allowed his mind to be manipulated by people who really don’t give a damn about him or his nation.

    It’s all about the greenbacks, baby.

  6. Lloyd Rowsey said on March 25th, 2008 at 5:25am #

    Hey, Don Hawkins. The piece by “James Hansen” you refer to has to do with CO2 emissions, not the financial markets. You may be my main man in Southern Georgia generally, but now you top my list of dorks who post “first strike diversionary” posts to articles here at DV. Two questions: (1) Are hp and messianicdruid real entities as far as you know (or are they constructs of “Don Hawkins” which you may or may not use following one of your First Strike Diversions)? And (2) How much money you got in the market?

  7. Lloyd Rowsey said on March 25th, 2008 at 5:55am #

    No, Don (or is it Donna?) Hawkins.

    It doesn’t matter if you’re really a po’ boy in Southern Georgia (running a drug store, right?) or some sort of employee of some supposed financial wizard, spreading little confusion-waves in unlikely places. Or even if you’re a nutty Greenie (environmentalist) . What you are versus what you purport to be does matter. And you’re no longer my main man, anywhere or anywho.

  8. hp said on March 25th, 2008 at 8:04am #

    Lloyd: pot-kettle-black.

  9. Lloyd Rowsey said on March 25th, 2008 at 1:22pm #

    Speak to Mike Whitney’s article, good posters.

    No hp, I’m different from Don. Like, these posts are trying to expose a “first strike diversionary” (not a bad term, wouldn’t you agree, hp?), not BE ONE. Just think if every poster was aware that such turds exist, and specialize in the long, complicated articles.

    And I could go on showing how I’m different from Don. But I won’t, and fuck you, hp. You’d like nothing better than my “going on” – ad nauseum. Good bye.

    Speak to Mike Whitney’s article, good posters.

  10. hp said on March 25th, 2008 at 2:10pm #

    Speaking of exposing people for what they are, Lloyd, I notice you never answered my question from the other post..

  11. Lloyd Rowsey said on March 25th, 2008 at 4:03pm #

    Which was?

  12. Lloyd Rowsey said on March 25th, 2008 at 4:23pm #

    Speak to Mike Whitney’s article, good posters.

    hp. If you can find the quotation to which you refer, consider emailing it to me — at moc.liamgnull@yesworlg — and we can continue your irrelevant pursuit there. I say irrelevant because whoever I AM, I am most certainly NOT a First Strike diversionary — assuming even you would not claim providing an http for a contribution to a good cause (and virtually nothing more) to be “diversionary.” On the other hand, I know who I am, so do you and the other readers of DV, and I am proud to be me.

    Speak to Mike Whitney’s article, good posters. (I don’t have the time, financial assets, or interest to read it.)

  13. hp said on March 25th, 2008 at 6:03pm #

    No Lloyd, I diversionary is not the word I had in mind.
    That’s neither here nor there.
    My question Lloyd, was asked after your rather spirited defense of the, in my opinion, despicable Bill Maher.
    I asked if you agree with the Zionist Bill Maher, as funny, charming and likable as he may be, thinking and saying it’s perfectly fine for American kids to die for the phony baloney apartheid state of Israel. Well, do you?

  14. Tom said on March 25th, 2008 at 7:43pm #

    Where is the picture of the Banksters?! I want to put it in my ‘untouchables looking worried’ file :-)

  15. Lloyd Rowsey said on March 26th, 2008 at 4:09am #

    No.

    And I’ll ask you a question that despite being the Addicted Diversionist and Misrepresentationist YOU obviously are – hp – you probably will not answer:

    Do you really think people reading Dissident Voice are so stupid and uniformed as to believe Bill Maher said “it’s perfectly fine for American kids to die for the phony baloney apartheid state of Israel?”

    Do you?

  16. hp said on March 26th, 2008 at 9:11am #

    You’re so sly Lloyd.

    No, I think they’re smart enough to believe he said it’s ok for American kids to die for Israel.
    Because he did say this.
    And he was shocked, shocked I tell you, that Michael Scheurer did not.

    Your question was right out of Orwell, Lloyd.
    Disingenuous and twisted. An infantile attempt to skew the truth. Very impressive.

    And your temper, complete with profanity and name calling is also real classy.

    You don’t own this blog and your name calling, feet stomping and childish temper tantrums, profanity included, won’t change that.

  17. hp said on March 26th, 2008 at 3:04pm #

    By the way, Lloyd, YOU are the one who brought up Bill Maher. Not me. Just as you make many off hand remarks which are called diversionary, etc. when others do the same but of course do not apply to you.
    As usual, you seem to be adept at a double standard which because of your ego you simply do not see.
    Pot-kettle-black.

  18. anthony innes said on March 28th, 2008 at 8:20pm #

    Dean Baker was on the Mcniel Leher report here in Oz on thursday 27th .It will not be long before Mike Whitney will be brought out to the”wider public ” to explain the bankruptcy of the USA.
    The Leaduhs in Congress have to IMPEACH or perish.
    Even Citizen Nader can see the writing on the wall.
    Watch what happens when capital flight from commodities leads to capital flight from food production .
    Address the article or get off. Mike ‘ s information is of world importance..

    \\\\\