[Marxism] Whitney on bailout: "Full spectrum breakdown, grasping at straws"

["Fred Feldman" <ffeldman@xxxxxxxxxxxxxxxx>]

http://www.counterpunch.org/whitney09202008.html

Weekend Edition
September 20 / 21, 2008

Full-Spectrum Breakdown 
Grasping at Straws 
By MIKE WHITNEY 

On Friday morning, Senator Christopher Dodd, the head of the Senate Banking
Committee, was interviewed on ABC's "Good Morning America." Dodd revealed
that just hours earlier at an emergency meeting convened by Secretary of the
Treasury Henry Paulson and Federal Reserve chairman Ben Bernanke, lawmakers
were told that  "We're literally maybe days away from a complete meltdown of
our financial system." Dodd added somberly, that in his three decades of
serving in public office, he had "never heard language like this." 

The system is at the breaking point, and despite Wall Street's elation from
the proposed $1 trillion dollar bailout to remove toxic mortgage-backed debt
from banks balance sheets, the market is still correcting in what has become
a vicious downward cycle. This cycle will persist until the bad debts are
accounted for and written off for or until the exhausted dollar-system
collapses altogether. Either way, the volatility and violent dislocations
will continue for the foreseeable future. 

Most people don't understand what happened on Thursday, but the build-up of
bad news on the Lehman default and the $85 billion government takeover of
AIG, triggered a run on the money markets and a freeze in interbank lending.
The overnight LIBOR rate (London Interbank Offered Rate) more than doubled
to 6.44 per cent. Bank of America reported overnight borrowing rates in
excess of 6 per cent. Longer-term LIBOR rates also rose sharply. On
Wednesday, jittery investors removed their money from money markets and
flooded short-term US Treasurys for the assurance of a government guarantee
on their savings even though interest rates had turned negative which means
that their balance would actually shrink at the date of maturity. This is
unprecedented, but it does help to illustrate how raw fear can drive the
market. 

The TED spread (the TED Spread measures market stress by revealing the
reluctance of banks to lend to each other) widened and the credit markets
froze in place. Borrowing three-month dollars on the interbank market and
the U.S. Treasury's three-month borrowing costs widened five full percentage
points. That's huge. The banking system shut down. 

What does it mean? It means the Federal Reserve has lost control of the
system. The market is driving interest rates now, and the market is
terrified. End of story.  

When the Fed announced its emergency program to dump $180 billion into the
global banking system, short term Libor retreated slightly but long-term
rates have remained stubbornly high. The noose continues to tighten. These
rates are pinned to 6 million US mortgages which will be resetting in the
next few years. That's more bad news for the housing industry. 

The entire system is deleveraging with the ferocity of a Force-5 gale
touching down in the Gulf, and yet, Henry Paulson has decided that the
prudent thing to do is build levees around the system with paper dollars.
Naturally, many people who understand the power of market-corrections are
skeptical. It won't work. Libor is pushing rates upwards--that's the "true"
cost of money. The Fed Funds rate (2 per cent) is supported by infusions of
paper dollars into the banking system to keep interest rates artificially
low. Now the extreme pace of deleveraging has the Fed on the ropes.
Trillions of dollars of credit is being sucked into a black hole which is
raising the price of money. It's out of Bernanke's control. He needs to step
out of the way and let prices fall or the dollar system will vanish in a
deflationary vacuum.  

The problems cannot be resolved by shifting the debts of the banks onto the
taxpayer. That's an illusion. By adding another $1 or $2 trillion dollars to
the National Debt, Paulson is just ensuring that interest rates will go up,
real estate will crash, unemployment will soar, and foreign central banks
will abandon the dollar. In truth, there is no fix for a deleveraging market
anymore than there is a fix for gravity. The belief that massive debts and
insolvency can be erased by increasing liquidity just shows a fundamental
misunderstanding of economics. That's why Henry Paulson is the worst
possible person to be orchestrating the so called rescue project. Paulson
comes from a business culture which rewards deception, personal
acquisitiveness, and extreme risk-taking. Paulson is to finance capitalism
what Rumsfeld is to military strategy. His leadership, and the congress'
pathetic abdication of responsibility, assures disaster. Besides, why should
the taxpayers be happy that the stocks of Morgan Stanley, Washington Mutual
and Goldman Sachs surged on the news that there would be a government
bailout yesterday? These banks are essentially bankrupt and their business
models are broken. Keeping insolvent banks on life support is not a rescue
plan; it's insanity. 

No one has any idea of the magnitude of the deleveraging ahead or the size
of the debts that will have to be written down. That's because 30 years of
deregulation has allowed a parallel financial system to arise in which over
$500 trillion dollars in derivatives are traded without any government
supervision or accounting. These counterparty transactions are interwoven
throughout the entire "regulated" system in a way that poses a clear and
present danger to the broader economy. It's a mess. For example, there are
an estimated $62 trillion of Credit Default Swaps (CDS) alone, which are
basically insurance policies for defaulting bonds. AIG was as heavily
involved in CDS as they were in regulated insurance products. So why would
AIG sell CDS rather than conventional insurance? 

Because, just like the banks, AIG could maximize its profits by minimizing
its capital cushion. In other words, it didn't really have the capital to
pay off claims when its CDS contracts began to blow up. If it had been
properly regulated, then government regulators would have made sure that it
was sufficiently capitalized with adequate reserves to pay off claims in a
down-market. Now taxpayers will pay for the lawless system which men like
"industry rep" Henry Paulson put in place. That's deregulation in a
nutshell; a system that allows Wall Street banksters to create credit out of
thin air and then run weeping to Congress when their swindles backfire. 

Inflating the currency, printing more money, and increasing the deficits
won't help. The bad debts have to be accounted for and liquidated. The
Paulson strategy is to create another ocean of red ink while refusing to
face the underlying problem head-on. This just further exacerbates the
consumer-led recession which economists know is already setting in
everywhere across the country. Demand is down and consumer spending is off
due to falling home equity, job losses, and tighter lending standards at the
banks. The broader economy does not need the added downward pressure from
higher taxes, bigger deficits, or inflation. Paulson's plan is a band-aid
approach to a sucking chest wound. The debts are enormous and the pain will
be substantial, but the problem cannot be resolved by crushing the middle
class or destroying the currency. 

The malfunctioning of the markets and the freeze-over in the banking system
are the outcome of a massive credit unwind instigated by trillions of
dollars of low interest credit from the Federal Reserve which was magnified
many times over via complex derivatives contracts and extreme leveraging by
speculative investment bankers. This has generated the biggest equity bubble
in history. That bubble is now set for a "hard-landing"  which is the
predictable result of an unsupervised marketplace where individual players
are allowed to create as much credit as they choose. 

Mike Whitney lives in Washington state. He can be reached at
fergiewhitney@xxxxxxx



________________________________________________
YOU MUST clip all extraneous text when replying to a message.
Send list submissions to: Marxism@xxxxxxxxxxxxxxxxxxx
Set your options at: 
http://lists.econ.utah.edu/mailman/options/marxism/archive%40archives.econ.utah.edu