Every Trick in the Book

Conditions have deteriorated on a scale and with a speed that no one could have predicted just a few months ago. Market conditions of unprecedented strength are roiling the world’s financial markets. The global economy is either in, or close to, recession and 2009 is not likely to be a year of great recovery.

— Brett White, chief executive officer of CB Richard Ellis, LA Times

Without any public debate or authorization from Congress, the Federal Reserve has embarked on the most expensive and radical financial intervention in history. Fed chairman Ben Bernanke is trying to avert another Great Depression by flooding the financial system with liquidity in an attempt to mitigate the effects of tightening credit and a sharp decline in consumer spending. So far, the Fed has committed over $7 trillion, which is being used to backstop every part of the financial system including money markets, bank deposits, commercial paper (CP) investment banks, insurance companies, and hundreds of billions of structured debt-instruments (MBS, CDOs). America’s free market system is now entirely dependent on state resources.

With interest rates at or below 1 percent, Bernanke is “zero bound”, which means that he will be unable to stimulate the economy through traditional monetary policy. That leaves the Fed with few choices to slow the debt-deflation that has already carved $7 trillion from US stock indexes and another $6 trillion from home equity. Bernanke will have to use unconventional means to stabilize the system and maintain economic activity in the broader economy.

Last Tuesday, Treasury Secretary Henry Paulson announced that the Fed would buy $600 billion of toxic mortgage-backed securities (MBS) from Fannie Mae and Freddie Mac, in effect, buying up its own debt. This is one of the unconventional strategies that Bernanke outlined in a speech he gave in 2002 on how to avoid deflation. By moving the MBS from Fannie’s balance sheet to the Fed’s, Bernanke was able down interest rates by a full percentage point overnight, creating a powerful incentive for anyone thinking about buying a home. But Bernanke’s plan is not risk free; it increases the Fed’s long-term liabilities, which in turn undermines the dollar. This calls into question the creditworthiness of the US Treasury, which is becoming more and more uncertain every day.

The Fed also initiated a program to purchase $200 billion of triple A-rated loans from non-bank financial institutions to try to revive the flagging securitization market. It’s another risky move that ignores the fact that investors are shunning “pools of loans” because no one really knows what they are worth. The appropriate way to establish a price for complex securities in a frozen market is to create a central clearinghouse where they can be auctioned off to the highest bidder. That establishes a baseline price, which is crucial for stimulating future sales. But the Fed wants to conceal the true value of these securities because there are nearly $3 trillion of them held by banks and other financial institutions. If they were priced at their current market value ($.21 on the dollar) then many of the country’s biggest banks would have to declare bankruptcy. So the Fed is trying to maintain the illusion of solvency by overpaying for these securities and providing the financing companies more capital to loan to businesses and consumers. Once again, the Fed is stretching its balance sheet by trying to resuscitate a structured finance system that has already proved to be dysfunctional.

Bernanke would be better off letting the market decide what these debt-instruments are really worth. There are always buyers if the price is right. Just look at what happened in Southern California last month, where there was a shocking turnaround in the housing market. Home sales in Orange Country shot up 55 percent year over year in October. That’s because prices have dropped 36 percent from their peak in 2007. This proves that real estate — like complex securities — will recover when investors feel that prices are fair.

Does Bernanke really believe that his maneuvering will change the direction of the market or convince investors to pay full-price for dodgy securities?

Who knows, but we do know that the Fed has no mandate to prop up asset values, which the market has already decided are worth considerably less. It’s the equivalent of price fixing.

Bernanke’s Bag O’ Tricks

In the coming weeks, the Fed chairman will probably employ many of the radical policy options he laid out in his 2002 speech. Economist Nouriel Roubini points out that nearly all of these choices “imply serious risks for the Fed” as well as the American people. Roubini says:

“Such risks include the losses that the Fed could incur in purchasing long term private securities, especially high yield junk bonds of distressed corporations . . . . Pushing the insolvent Fannie and Freddie to take even more credit risk may be a reckless policy choice. And having a government trying to manipulate stock prices would create another whole can of worms of conflicts and distortions.

Finally, the Fed could try to follow…massive quantitative easing; flooding markets with unlimited unsterilized liquidity; talking down the value of the dollar; direct and massive intervention in the forex to weaken the dollar; vast increase of the swap lines with foreign central banks… aimed to prevent a strengthening of the dollar; attempts to target the price level or the inflation rate via aggressive preemptive monetization; or even a money-financed budget deficit.” (Nouriel Roubini’s EconoMonitor)

Last Tuesday’s announcement suggests that Bernanke may be dabbling in the stock market already. This forces anyone who is planning to short the market to reconsider his strategy because Bernanke could be secretly betting against him by dumping billions in the futures market to keep stocks artificially high. It just goes to show that all the bloviating about the virtues of “free market” is just empty rhetoric. When push comes to shove this is “their” system and they’ll do whatever they can to preserve it. If that means direct intervention, so be it. Principles mean nothing.

Bernanke’s actions are likely to wreak havoc in the currency markets, too. If currency traders suspect that Bernanke is printing money (“unsterilized liquidity”) to rev up the economy, there will be a sell-off of US Treasuries and a run on the dollar. “Monetization” — the printing money to cover one’s debts — is the fast-track to hyperinflation and the destruction of the currency. It’s not a decision that should be taken lightly. And it is not a decision that should be made by a banking oligarch who has not been given congressional approval. Bernanke’s shenanigans show an appalling contempt for the democratic process. He needs to be reigned in before he does more damage.

Bernanke’s attempts to revive the securitization market is understandable, but it probably won’t amount to anything. The well has already been poisoned by the lack of regulation and the proliferation of subprime loans. The problem is that the broader economy needs the credit that securitization produced via the non bank financials (investment banks, hedge funds etc) In fact, the non bank financial institutions were providing the lion’s share of the credit to the financial system before the meltdown. But, now that the five big investment banks are either bankrupt or transforming themselves into holding companies (and the hedge funds are still deleveraging) the only option for credit is the banks, and they are incapable of filling the void. The Wall Street Journal estimates that the loss of Bear Stearns and Lehman Bros. will mean “$450 billion in lending capacity missing from markets”. Think about that. If we include the other investment banks in the mix, then more than $2 trillion in credit will vanish from the system next year alone. Bottom line, the breakdown in securitization is choking off credit and pushing the country towards catastrophe. If the slide continues, there could be a 40 percent reduction in credit in 2009 making another great Depression unavoidable.

Does that mean we should revive the failed system?

No, just the opposite. The markets need to be re-regulated now to restore credibility. But the Fed should looking for ways to create an emergency National Bank, which operates like a public utility, so that credit can be made available to businesses and consumers who need it now. The Treasury should also be working with Congress on a plan for public education to forestall a panic as well as recommendations for stimulus to soften the economic hard landing just ahead.

The financial system is broken and institutions will not be able to releverage fast enough to normalize the credit markets or stop the impending collapse in consumer demand. What’s needed is a constructive plan to rebuild the system while minimizing the suffering of normal people. There’s no sense in trying to put the genie back in the bottle or re-energize a failed system. What’s past is prologue. There needs to be a serious analysis of the factors that led to the present crack-up and a plan for course-correction. It’s not enough to throw stones at the Fed and its misguided serial bubble-making escapades.

Reagan’s Legacy

Our present dilemma can be traced back to the 1980s — the Reagan era — and the rise of an organized, industry-funded movement, which advanced their business-friendly, “trickle down” ideology which, when put into practice, has led to greater and greater income disparity, unprecedented expansion of credit and, ultimately, economic disaster.

The problem is the way that the system has been reworked to serve the interests of the investor class at the expense of working people. As Wall Street has tightened its grip on the political parties, more of the nation’s wealth has gone to a smaller percentage of the population while the chasm between rich and poor has grown wider and wider. The United States now has the worst income and wealth disparity since 1929 and a whopping 75 percent of the labor force has seen a drop in their living standard since 1973. The average American has no savings and a pile of bills he is less and less able to pay. Apart from the ethical questions this raises, there is the purely practical matter of how a consumer-driven economy (GDP is 70% consumer spending in US) can maintain long-term growth when wages do not keep pace with productivity. It’s simply impossible. The only way the economy can grow is if wages are augmented with personal debt; and that is exactly what has happened. The fake prosperity of the Bush and Clinton years can all be attributed to the unprecedented and destabilizing expansion of personal debt. Wages have been stagnate throughout.

The architects of the present system knew what they were doing when they cooked up their supply side theory. They were creating the rationale for shifting wealth from one class to another. But the theory is deeply flawed as the current crisis proves. Economic conditions do not improve when the rich get richer. All boats do not rise. Class divisions intensify and imbalances grow. Equity bubbles may be an effective means of social engineering, but they always lead to disaster. In fact, the crash of the Fed’s massive debt bubble could bring down the whole system in heap. There are better ways to allocate resources so that everyone benefits equally.

It all gets down to wages, wages, wages. If wages don’t grow, neither will the economy. Author Ravi Batra sums it up like this in his book Greenspan’s Fraud:

“A bubble economy is born when wages trail productivity for some time and result in ever-rising debt. Then profits grow faster than productivity gains, and share prices outpace GDP growth. However, a time comes when debt-growth slows down, and demand falls short of output, resulting in profit decline and a stock market crash. Thus, the very force that generates the stock market bubble seeds its crash.” (Greenspan’s Fraud: Ravi Batra, Palgrave Macmillan, p 152)

The “trickle down” Voodoo economic model was destined to fail because it was built on a fiction. Prosperity is not possible when workers are not fairly compensated and wealth is not equitably distributed. Our focus should be on creating a system that is sustainable, which means that the needs of workers should take precedent over those of Wall Street.

Mike Whitney lives in Washington state. He can be reached at: fergiewhitney@msn.com. Read other articles by Mike.

10 comments on this article so far ...

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  1. Ramsefall said on December 2nd, 2008 at 10:34am #

    Workers have been neglected along with their wages for decades or longer, but wage stagnation is beneficial for profit, and that is their primary concern.

    With all this Fed backing, what’ll be done when the Fed goes belly up? Print more money and completely devalue the dollar? These reckless and self-promoting, unregulated measures with no transparency will come at a heavy price. By buying up all the junk bonds and mortgage-backed securities, they’re shooting off the nation’s feet. Who’ll be able to run from the building when it goes up in flames?

    Thanks Mike.

    Best to you.

  2. Don Hawkins said on December 2nd, 2008 at 11:39am #

    Tax and 100% dividend. A “carbon tax with 100 percent dividend” is required for
    reversing the growth of atmospheric CO2. The tax, applied to oil, gas and coal at the mine or
    port of entry, is the fairest and most effective way to reduce emissions and transition to the
    post fossil fuel era. It would assure that unconventional fossil fuels, such as tar shale and tar
    sands, stay in the ground, unless an economic method of capturing the CO2 is developed.
    The entire tax should be returned to the public, equal shares on a per capita basis (half
    shares for children up to a maximum of two child-shares per family), deposited monthly in
    bank accounts. No bureaucracy is needed.
    A tax should be called a tax. The public can understand this and will accept a tax if it is
    clearly explained and if 100 percent of the money is returned to the public. Not one dime
    should go to Washington for politicians to pick winners. No lobbyists need be employed.
    The public will take steps to reduce their emissions because they will continually be
    reminded of the matter by the monthly dividend and by rising fossil fuel costs. It must be
    clearly explained to the public that the tax rate will continue to increase in the future. Hansen

    Our focus should be on creating a system that is sustainable, which means that the needs of workers should take precedent over those of Wall Street. Tell me that Hansen is wrong and not only the needs of the workers take precedent but the workers family as well. This is a new way of thinking and yes only part of creating a new system but a big part. The time is now. President Obama do you read DV I sure hope you do use the knowledge there are many great minds out there who will help you use the knowledge.

  3. Giorgio said on December 2nd, 2008 at 12:07pm #

    My question is where does the Fed get all those $Trillion dollars from?
    From the banksters Rothschilds and Co. with shyster Shylock’s interest added on ? OR as Ron Paul puts it neatly: printing dollars out of thin air?
    Then why doesn’t the Fed make it simple: provide mini-printing machines to every American household so that they can print their own dollars to their heart’s content, go on a spending spree and make this Xmas season the greatest success ever ….
    Bernanke! Use the sludge between your ears, Stupid!
    Make it simple so that Americans won’t have to pay interest to a cabal banksters like the Rothschilds….

  4. Ramsefall said on December 2nd, 2008 at 12:38pm #


    your second guess is correct, they just print it out of thin air essentially. Since the dollar had the gold standard removed under Nixon, what capitalism revolves around now are pieces of paper with dead presidents faces, denominations and occult symbolism reflective of their plutocratic hegemony and elite vow of silence.

    They can’t tweak the system so the people don’t pay interest on debt, because debt is what obligates prisoners of society to go get a crumby job and keep the cycle in motion. If there was no debt, nobody would need a job and their system would collapse.

    As for money printing, the more they print, the less it is worth and concurrently the debt rises proportionally. Anymore the majority is all electronic, even more worthless. While being very real, it’s also very illusory.

    Best to you.

  5. Don Hawkins said on December 2nd, 2008 at 12:57pm #

    One point that could gainfully be factored in, but is left out in the cold, by scientists, researchers and policy makers, is the influence peace can have in bringing down global warming.

    Just imagine all the resources consumed in developing, maintaining and transporting the astronomical quantities of all kinds of arms and ammunition around the world. And all that is consumed in the upkeep of the personnel of the forces across the globe.

    Also take into account the resource consumption in the transport of personnel, ships and air force jets. Then, personnel in inhospitable climates and terrains, as in biting cold temperatures and where habitation is very sparse, would depend on burning fossil fuel. What is the impact of all this on global warming and thereby on climate change? Wouldn’t the figures of all these components be mind boggling?

    In noted economist Paul Samuelson’s terminology it is the allocation of an economy’s scarce resources between “guns and butter”. More guns means less butter. All because of the threat of war. And what happens to the environment? All the wasteful resource consumption to fight the threat of war accentuates global warming.

    Wouldn’t we be better off with peace, goodwill and cordial relations between nations and checking global warming? Peace is eco-friendly. In the words of Ralph Waldo Emerson: “The real and lasting victories are those of peace, and not of war.” N Kalyani, ET Bureau

    He wanted to be President and anything but boring is one way of looking at it. Use the knowledge and that gift of gab.

  6. DavidG. said on December 2nd, 2008 at 1:33pm #

    But Don, war makes money, lots of it. Peace doesn’t!

    If we could get rid of the evil concept of capitalism, then peace might stand a chance.

  7. Ramsefall said on December 2nd, 2008 at 1:47pm #

    DavidG and Don,

    if stewardship of the Earth and love for ourselves were the priorities, we simply wouldn’t live in such a system based on money that excludes the masses from attaining the resources they need to survive. There are alternatives to resource allocation and the intelligently sustained management thereof for future generations.

    Humanity though, has been in the eternal process of subjugation to powers strictly guided by their egos who realized long ago the ease of maintaining their power more effectively through the use of a controlled monetary system. But as David indicates, any solution which is not profitable is not going to be implemented. No profit, no priority.

    Best to all.

  8. Don Hawkins said on December 2nd, 2008 at 5:23pm #

    Here is one suggestion: the next President should ask the National Academy of Sciences to provide him a prompt assessment of the situation. After all, Abraham Lincoln established our Academy for just such purpose. Interestingly, at the beginning of the current administration, in early 2001, the President asked the Academy for a (albeit limited) assessment of global warming, apparently under the belief that the Academy would be critical of the most recent report of the Intergovernmental Panel on Climate Change. Well, the Academy’s report did have some criticisms, but, with clarity and authority, it reiterated the reality of global warming, the predominant role of humans in causing the warming, and the need for a policy response to minimize climate problems. The administration was apparently so taken aback that they never asked the Academy again for any broad advice on the topic. It does not do much good to cry over that tragedy – now is the time to figure out the best way forward from this point. That’s The National Academy of Sciences and fast would be good.

  9. Don Hawkins said on December 2nd, 2008 at 5:26pm #

    Oh that was James Hansen who wrote that. I put a lot of his stuff as he is one of the smartest people on the Planet and tuff, gut’s.

  10. Ramsefall said on December 2nd, 2008 at 6:38pm #

    I suppose the main discrepancy I see with your well-intentioned suggestion, Don, is that if other administrations along with the current one have been shocked by findings presented by the NAS, and then set out to do exactly the opposite of what is needed, why would the next President respond any differently?

    While abundant solutions have been available for years, a committed shift toward implementation of those technologies/solutions threatens many of the entities with controlling interest of the Establishment. Advanced non-petroleum-based technologies threaten the petroleum industry on which the industrialized world, especially our corner, is dependent. The topic can’t really even be addressed publicly as you’ve noticed in past elections or the media, and thus it won’t change at those hands. Of course the pink elephant in the room is the unprecedented profit already reaped by the cartel heads keeping things the way they are since anthropocentric environmental damage warnings began surfacing decades ago. As such, expecting any president to heed the results of the scientific community is far fetched, from how I see things at least.

    I think a more practical and active solution is for people to start making their own changes to whatever extent they can; boycotting petro to whatever extent you can through alternatives like hybrids, bicycle, public transport depending on where you live, carpool, etc; the semi-affordable use of solar panels to get you off the grid, or stay on and sell back your excess; wind power couples very efficiently with solar, regional dependent of course; conservation at home, heat pumps and energy efficient furnaces and bulbs, insulation, you could probably come up with more. When your neighbors see you doing it, provided they didn’t just loose their house or job, and realize the benefits and liberation in that, it could become infectious.

    But who knows, I never claimed to bat .400 or shoot par.

    Best to you, Don.