The Collapse of the Modern Day Banking System

[Douglas Caddy]

The Collapse of the Modern Day Banking System

Staring Into the Abyss

By MIKE WHITNEY

December 17, 2007

Counterpunch.org

http://www.counterpunch.org/

Stocks fell sharply last week on news of accelerating inflation which will limit the Federal Reserves ability to continue cutting interest rates. On Tuesday the Dow Jones Industrials tumbled 294 points following the Fed's announcement of a quarter point cut to the Fed Funds rate. On Friday, the Dow dipped another 178 points when government figures showed consumer prices had risen 0.8 per cent last month after a 0.3 per cent gain in October. The stock market is now lurching downward into a "primary bear market". There has been a steady deterioration in retail sales, commercial real estate, and the transports. The financial industry is going through a major retrenchment, losing more than 25 per cent in aggregate capitalization since July. The real estate market is collapsing. California Gov. Arnold Schwarzenegger announced on Friday that he will declare a "fiscal emergency" in January and ask for more power to deal with the $14 billion budget shortfall from the meltdown in subprime lending.

Economists are beginning to publicly acknowledge what many market analysts have suspected for months; the nation's economy is going into a tailspin.

Morgan Stanley's Asia Chairman, Stephen Roach, made this observation in a New York Times op-ed on Sunday:

This recession will be deeper than the shallow contraction earlier in this decade. The dot-com-led downturn was set off by a collapse in business capital spending, which at its peak in 2000 accounted for only 13 percent of the country's gross domestic product. The current recession is all about the coming capitulation of the American consumer - whose spending now accounts for a record 72 percent of G.D.P.

Most people have no idea how grave the present situation is or the disaster the country will face if trillions of dollars of over-leveraged bonds and equities begin to unwind. There's a widespread belief that the stewards of the system - Bernanke and Paulson - can somehow steer the economy through this "rough patch" into calm waters. But they cannot, and the presumption shows a basic misunderstanding of how markets work. The Fed has no magical powers and will not allow itself to be crushed by standing in the path of a market-avalanche. As foreclosures and bankruptcies increase; stocks will crash and the fed will step aside to safety.

In the last few weeks, Bernanke and Paulson have tried a number of strategies that have failed. Paulson concocted a plan to help the major investment banks consolidate and repackage their nonperforming mortgage-backed junk into a "Super SIV" to give them another chance to unload their bad investments on the public. The plan was nothing more than a public relations ploy which has already been abandoned by most of the key participants. Paulson's involvement is a real black eye for the Dept of the Treasury. It makes it look like he's willing to dupe investors as long as it helps his d Wall Street buddies.

Paulson also put together an "industry friendly" rate freeze that is supposed to help struggling homeowners avoid foreclosure. But the plan falls well short of providing any meaningful aid to the estimated 3.5 million homeowners who are facing the prospect of defaulting on their loans if they don't get government assistance. Recent estimates by industry experts say that Paulson's plan will only help 140,000 mortgage holders, leaving millions of others to fend for themselves. Paulson has proved over and over that he is just not up to the task of confronting an economic challenge of this magnitude head-on.

Fed chief Bernanke hasn't done much better than Paulson. His three-quarter point cut to the Fed's Funds rate hasn't lowered interest rates on mortgages, stimulated greater home sales, stabilized the stock market or helped banks deal with their massive debt-load. It's been a flop from start to finish. All it's done is weaken the dollar and trigger a wave of inflation. In fact, government figures now show energy prices are rising at 18.1 per cent annually. Bernanke is apparently following Lenin's supposed injunction  though there's no conclusive evidence he actually said it -- that "the best way to destroy the Capitalist System is to debauch the currency."

On Wednesday, the Federal Reserve initiated a "coordinated effort" with the Bank of Canada, the Bank of England, the European Central Bank, the and the Swiss National Bank to address the "elevated pressures in short-term funding of the markets." The Fed issued a statement that "it will make up to $24 billion available to the European Central Bank (ECB) and Swiss National Bank to increase the supply of dollars in Europe." (Bloomberg) The Fed will also add as much as $40 billion, via auctions, to increase cash in the U.S. Bernanke is trying to loosen the knot that has tightened Libor (London Interbank Offered Rate) rates in England and reduced lending between banks. The slowdown is hobbling growth and could send the world into a recessionary spiral. Bernanke's "master plan" is little more than a cash giveaway to sinking banks. It has scant chance of succeeding. The Fed is offering $.85 on the dollar for mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) that sold last week in the E*Trade liquidation for $.27 on the dollar. At the same time, the Fed has promised to keep the identities of the banks that are borrowing these emergency funds secret from the public. The Fed is conducting its business like a bookie.

Unfortunately, the Fed bailout has achieved nothing. Libor rates---which are presently at seven-year highs---have not come down at all. This is causing growing concern among the leaders of the Central Banks around the world, but there's really nothing they can do about it. The banks are hoarding cash to meet their capital requirements. They are trying to compensate for the loss of value to their (mortgage-backed) assets by increasing their reserves. At the same time, the system is clogged with trillions of dollars of bad paper which has brought lending to a halt. The huge injections of liquidity from the Fed have done nothing to improve lending or lower interbank rates. It's been a flop. The market is driving interest rates now. If the situation persists, the stock market will crash.

Staring Into the Abyss

One of Britain's leading economists, Peter Spencer, issued a warning on Saturday:

The Government must suspend a set of key banking regulations at the heart of the current financial crisis or risk seeing the economy spiral towards a future that could make 1929 look like a walk in the park.

Spencer is right. The banks don't have the money to loan to businesses or consumers because they're trying to raise more cash to meet their capital requirements on assets that continue to be downgraded. (The Fed may pay $.85 on the dollar, but investors are unwilling to pay anything at all.)Spencer correctly assumes that the reason the banks have stopped lending is not because they "distrust" other banks, but because they are capital-strapped from all their "off balance" sheets shenanigans. If the Basel regulations aren't modified, money markets will remain frozen, GDP will shrink, and there'll be a wave of bank closings.

Spencer said:

The Bank is staring into the abyss. The Financial Services Authority must go round and check that all banks are solvent, and then it should cut the Basel capital requirement level from 8pc to about 6pc. ("Call to Relax Basel Banking Rules, UK Telegraph)

Spencer confirms what we already knew; the banks are seriously under-capitalized and will come under growing pressure as hundreds of billions of dollars of mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) continue to lose value and have to be propped up with additional capital. The banks simply don't have the resources and there's going to be a day of reckoning.

Pimco's Bill Gross put it like this: "What we are witnessing is essentially the breakdown of our modern day banking system." Gross is right, but he only covers a small portion of the problem.

The economist Ludwig von Mises is more succinct in his analysis:

There is no means of avoiding the final collapse of a boom brought on by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

The basic problem originated with the Federal Reserve when former Fed chief Alan Greenspan lowered interest rates below the rate of inflation for 31 months straight which pumped trillions of dollars of low interest credit into the financial system and ignited a speculative frenzy in real estate. Greenspan has spent a great deal of time lately trying to avoid any blame for the catastrophe he created. He is a first-rate "buck passer". In Wednesday's Wall Street Journal, Greenspan scribbled out a 1,500-word defense of his actions as head of the Federal Reserve, pointing the finger at everything from China's "low cost workforce" to "the fall of the Berlin Wall". The essay was typical Greenspan gibberish. In his trademark opaque language; Greenspan tiptoes through the well-documented facts of his tenure as Fed chief to absolve himself of any personal responsibility for the ensuing disaster.

Greenspan's apologia is a masterpiece of circuitous logic, deliberate evasion and utter denial of reality. He says:

I do not doubt that a low U.S. federal-funds rate in response to the dot-com crash, and especially the 1 per cent rate set in mid-2003 to counter potential deflation, lowered interest rates on adjustable-rate mortgages (ARMs) and may have contributed to the rise in U.S. home prices. In my judgment, however, the impact on demand for homes financed with ARMs was not major.

"Not major"? 3.5 million potential foreclosures, 11-month inventory backlog, plummeting home prices, an entire industry in terminal distress pulling down the global economy is not major?

But Greenspan is partially correct. The troubles in housing cannot be entirely attributed to the Fed's "cheap credit" monetary policies. They were also nursed along by a Doctrine of Deregulation which has permeated US capital markets since the Reagan era. Greenspan's views on how markets should function were -- to great extent -- shaped by this non-interventionist/non-supervisory ideology which has created enormous equity bubbles and imbalances. The former-Fed chief's support for adjustable-rate mortgages (ARMs) and subprime lending shows that Greenspan thought of himself as more as a cheerleader for the big market-players than an impartial referee whose job was to monitor reckless or unethical behavior.

Greenspan also adds this revealing bit of information in his article:

The value of equities traded on the world's major stock exchanges has risen to more than $50 trillion, double what it was in 2002. Sharply rising home prices erupted into major housing bubbles world-wide, Japan and Germany (for differing reasons) being the only principal exceptions." ("The Roots of the Mortgage Crisis", Alan Greenspan, Wall Street Journal)

This admission proves Greenspan's culpability. If he knew that stock prices had doubled their value in just 3 years, then he also knew that equities had not risen due to increases in productivity or demand.(market forces) The only reasonable explanation for the asset inflation, therefore, was monetary policy. As his own mentor, Milton Friedman famously stated, "Inflation is always and everywhere a monetary phenomenon". Any capable economist would have known that the explosion in housing and equities prices was a sign of uneven inflation. Now that the bubble has popped, inflation is spreading like mad through the entire economy.

Greenspan is a very sharp man. It is crazy to think he didn't know what was going on. This is basic economic theory. Of course he knew why stocks and housing prices were skyrocketing. He was the one who put the dominoes in motion with the help of his printing press.

But Greenspan's low interest credit is only part of the equation. The other part has to do with way that the markets have been transformed by "structured finance".

What's so destructive about structured finance is that it allows the banks to create credit "out of thin air", stripping the Fed of its role as controller of the money supply. David Roache explains how this works in an excerpt from his book "New Monetarism" which appeared in the Wall Street Journal:

The reason for the exponential growth in credit, but not in broad money, was simply that banks didn't keep their loans on their books any more-and only loans on bank balance sheets get counted as money. Now, as soon as banks made a loan, they "securitized" it and moved it off their balance sheet.

There were two ways of doing this. One was to sell the securitized loan as a bond. The other was "synthetic" securitization: for example, using derivatives to get rid of the default risk (with credit default swaps) and lock in the interest rate due on the loan (with interest-rate swaps). Both forms of securitization meant that the lending bank was free to make new loans without using up any of its lending capacity once its existing loans had been "securitized."

So, to redefine liquidity under what I call New Monetarism, one must add, to the traditional definition of broad money, all the credit being created and moved off banks' balance sheets and onto the balance sheets of nonbank financial intermediaries. This new form of liquidity changed the very nature of the credit beast. What now determined credit growth was risk appetite: the readiness of companies and individuals to run their businesses with higher levels of debt. (Wall Street Journal)

The banks have been creating trillions of dollars of credit (by originating mortgage-backed securities, collateralized debt obligations and asset-backed commercial paper) without maintaining the proportional capital reserves to back them up. That explains why the banks were so eager to provide mortgages to millions of loan applicants who had no documentation, no income, no collateral and a bad credit history. They believed there was no risk, because they were making enormous profits without tying up any of their capital. It was, quite literally, money for nothing.

Now, unfortunately, the mechanism for generating new loans (and fees) has broken down. The main sources of bank revenue have either been seriously curtailed or dried up entirely. (Mortgage-backed) Commercial paper (ABCP) one such source of revenue, has decreased by a full-third (or $400 billion) in just 17 weeks. Also, the securitization of mortgage-backed securities is DOA. The market for MBSs and CDOs and other complex bonds has followed the Pterodactyl into the history books. The same is true of structured investment vehicles (SIVs) and other "off balance-sheet" swindles which have either gone under entirely or are presently withering with every savage downgrade in mortgage-backed bonds. The mighty juggernaut that was grinding out the hefty profits ("structured investments") has suddenly reversed and is crushing everything in its path.

The banks don't have the reserves to cover their downgraded assets and the Federal Reserve cannot simply "monetize" their bad bets. There's no way out. There are bound to be bankruptcies and bank runs. "Structured finance" has usurped the Fed's authority to create new credit and handed it over to the banks.

Now everyone will pay the price.

Investors have lost their appetite for risk and are steering clear of anything connected to real estate or mortgage-backed bonds. That means that an estimated $3 trillion of securitized debt (CDOs, MBSs and ASCP) will come crashing to earth delivering a violent blow to the economy.

It's not just the banks that will take a beating. As Professor Nouriel Roubini points out, the broker dealers, the investment banks, money market funds, hedge funds and mortgage lenders are in the crosshairs as well.

Non-bank institutions do not have direct access to the Fed and other central banks liquidity support and they are now at risk of a liquidity run as their liabilities are short term while many of their assets are longer term and illiquid; so the risk of something equivalent to a bank run for non-bank financial institutions is now rising. And there is no chance that depository institutions will re-lend to these to these non-banks the funds borrowed by central banks as these banks have severe liquidity problems themselves and they do not trust their non-bank counterparties. So now monetary policy is totally impotent in dealing with the liquidity problems and the risks of runs on liquid liabilities of a large fraction of the financial system. (Nouriel Roubini's Global EconoMonitor)

As the downgrades on CDOs and MBSs continue to accelerate, there'll likely be a frantic "flight to cash" by investors, just like the recent surge into US Treasuries. This could well be followed by a series of spectacular bank and non-bank defaults. The trillions of dollars of "virtual capital" that were miraculously created through securitzation when the market was buoyed-along by optimism will vanish in a flash when the market is driven by fear. In fact, the equity bubble has already been punctured and the process is well underway.

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

[Guest David Guyatt]

Profligate lending and the creation of money out of thin air in order to generate this year's profits and this year's bonuses is not at all a new phenomenon in the long history of banking and finance.

If you lend trillions of dollars that don't really exist, and lend them to people who you know in advance can't possibly repay the amounts they've borrowed, what else can you expect to happen? Sooner or later the chickens must come home to roost.

As one savvy commentator pointed out, the banking industry has had a fabulous run these past years and enjoyed the enormous profiteering. Now when the expected can no longer be fobbed off, they want the government and regulators to bail them out.

Reducing the Basle Accord criteria will merely allow further off balance sheet shenaningans to take place out of the public eye.

[John Simkin]

The problems of the British banking system can be seen with the government support of Northern Rock. The government's aid package for the bank now amounts to about £57bn. (Three times our annual defence budget). It has offered to cover any loss by financial institutions that provide money to Northern Rock so the bank can operate normal banking services. The Treasury made the move to ensure that the Northern Rock received enough funding from the money markets to survive into the New Year. But it means that each taxpayer has a £2,000 exposure to the stricken bank.

As Vince Cable of the Liberal Democrats has pointed out: "The government now seems to have got the worst of all possible worlds. It's effectively nationalised the liabilities of the bank, while at the same time it doesn't control it."

[Guest David Guyatt]

The problems of the British banking system can be seen with the government support of Northern Rock. The government's aid package for the bank now amounts to about £57bn. (Three times our annual defence budget). It has offered to cover any loss by financial institutions that provide money to Northern Rock so the bank can operate normal banking services. The Treasury made the move to ensure that the Northern Rock received enough funding from the money markets to survive into the New Year. But it means that each taxpayer has a £2,000 exposure to the stricken bank.

As Vince Cable of the Liberal Democrats has pointed out: "The government now seems to have got the worst of all possible worlds. It's effectively nationalised the liabilities of the bank, while at the same time it doesn't control it."

And conversely, this is the best of all possible worlds for the banking fraternity who do not have to worry about their exposure and risk, but just cream in the profits...

It's such a nonsensical and unjust imbalance of priorities that it makes me spit in fury.

[Douglas Caddy]

Profligate lending and the creation of money out of thin air in order to generate this year's profits and this year's bonuses is not at all a new phenomenon in the long history of banking and finance.

If you lend trillions of dollars that don't really exist, and lend them to people who you know in advance can't possibly repay the amounts they've borrowed, what else can you expect to happen? Sooner or later the chickens must come home to roost.

As one savvy commentator pointed out, the banking industry has had a fabulous run these past years and enjoyed the enormous profiteering. Now when the expected can no longer be fobbed off, they want the government and regulators to bail them out.

Reducing the Basle Accord criteria will merely allow further off balance sheet shenaningans to take place out of the public eye.

The World's Largest Banks Are Now Trapped

by Gary North

www.lewrockwell.com

December 19, 2007

http://www.lewrockwell.com/north/north591.html

The subprime mortgage crisis constitutes the worst banking error in my lifetime. Nothing else comes close.

It has visibly begun to unravel. The European Central Bank on Tuesday, December 18, opened a line of credit of $500 billion to commercial banks.

The Federal Reserve System under Greenspan was the prime instigator. It forced down short-term interest rates by supplying the overnight bank-to-bank loan market with sufficient liquidity to drop the rate to 1%. This encouraged banks to make loans at low rates.

These loans were short-term loans. The borrowers then went out and bought long-term assets: bonds and mortgages. This is known as the carry trade. The pioneering central bank in the carry trade was the Bank of Japan. It lowered short-term rates from about 7% in 1990 to just above zero in 1999, where it stayed until mid-2006. But the yen is not the world's reserve currency. The U.S. dollar is.

Through a complex combination of government-licensed monopoly (Federal Reserve System), implied government safety nets for mortgage investors (Fannie Mae and Freddy Mac), creative finance (asset-backed securities), and credit-rating services that were either stunningly naïve or compensated in ways not beneficial to objective analysis, brokers marketed a series of high-commission, fast-sale investment packages that sold like hotcakes until August, 2007. Then, without warning, they stopped selling.

These packages had sold all over the world. European banks got in on the action, marketing these investment packages to their clients.

Americans have seen all this before: the savings and loan crisis of the 1980's. The S&L's were borrowed short (depositors) and lent long (home buyers). Then the rules changed. The government in 1980 abolished Regulation Q, which had limited the rate of interest that banks and S&L's could pay to depositors. A rate war began.

The government had little choice. Money market funds, which had been invented around 1975, were not under the banking system. They were not bound by Regulation Q. They were paying high rates on short-term money. Depositors were pulling funds out of banks and buying money-market funds. The banks were hemorrhaging.

As soon as the banks could compete with money market funds, the S&L's were doomed. Their money was tied up for 30 years. Depositors (legally, owners) were cashing in. It was It's a Wonderful Life without the honeymoon money.

Then Congress stepped in with its own honeymoon money: about half a trillion dollars, if you count interest on the national debt.

That was the test of the mortgage carry trade. The system failed. We are now in the midst of another similar test. It is much larger. It is worldwide. It is affecting capital markets that were once far-removed from mortgages.

MAKING HAY WHILE THE SUN SHINED

You have heard of NINJA loans: no income, no job or assets. These were loans made by local mortgage brokers to first-time home buyers. Poor people were offered loans at rates far lower than conventional loans. The brokers told the prospective debtors that they could re-finance later to get long-term loans. This was not put in writing, and so it cannot be proven. But everyone in the industry knew it was being done. Therein lies the trap for America's largest banks. "Everyone knew."

If lawyers can persuade juries that everyone knew, America's largest banks are on the hook for more money in reparations than they have as capital. Why? Fraud. They sold investors, including European banks, investments known to be fraudulent.

Here it is, folks: what we have dreamed about. The money-grubbing lawyers are about to wipe out the money-grubbing bankers. There is only one hitch: the world's economy could crash. Darn!

In the December 9 issue of the San Francisco Chronicle ran a great headline:

MORTGAGE MELTDOWN

It had even better subheads:

Interest rate 'freeze' – the real story is fraud

Bankers pay lip service to families while scurrying to avert suits, prison

The author, Sean Olender, is a lawyer. He explained what he thinks the Secretary of the Treasury Henry Paulson and the banks are really up to. It's not about helping poor homeowners. (You probably suspected this.)

The present bailout proposal was not the first one. He describes earlier ones.

First the Treasury Department urged the creation of a new fund that would buy risky mortgage bonds as a tactic to hide what those bonds were really worth. (Not much.) Then the idea was to use Fannie Mae and Freddie Mac to buy the risky loans, even if it was clear that U.S. taxpayers would eventually be stuck with the bill. But that plan went south after Fannie suffered a new accounting scandal, and Freddie's existing loan losses shot up more than expected.

The first was the old standby: a government-funded bailout. This was the now-familiar S&L solution. It did not pass muster. It may a year from now. The second was a bailout by two of the perps. But their capital is tied up in mortgages. The flow of investors' new funds is faltering. These two agencies need honeymoon money. They are in no position to provide it.

Now, just unveiled Thursday, comes the "freeze," the brainchild of Treasury Secretary Henry Paulson. It sounds good: For five years, mortgage lenders will freeze interest rates on a limited number of "teaser" subprime loans. Other homeowners facing foreclosure will be offered assistance from the Federal Housing Administration.

Mr. Olender is not persuaded by the sincerity of the offer. He perceives this as a judicial move, not an economic move. He sees it as the government's attempt to place a legal moat around the banks' castles.

The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value – right now almost 10 times their market worth.

Not being a lawyer, I am willing to ascribe economic motives as well. If whole neighborhoods face eviction, they are likely to decline very rapidly into residences of illegal drug salesmen and crackheads. These houses are not in upscale parts of town. Once in decline, borderline neighborhoods are almost impossible to restore. The value of the lenders' capital is at risk. Keeping homeowners in their homes does make economic sense. The flow of mortgage payments remains. The houses are maintained. But I digress.

The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.

And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies – all the way up to senior management – knew about it.

That is the supposed key to the prosecution: "Everyone knew." If everyone knew, then defrauded investors have a legal case. Anyway, they would have a case if they were not trying to collect from the real masters of America, the multinational banks.

There are lots of people who would like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy time and make this all go away. Cuomo is just inches from getting what he needs to start putting a lot of people in prison. I bet some people are trying right now to make him an offer "he can't refuse."

Here we have an attorney general who understands how his immediate predecessor became the Governor of New York: handing out lots of subpoenas to big business CEO's. Cuomo has a severe case of subpoena envy.

Mr. Olender then gets to the heart of the matter: the bottom line. What is the bottom line? The bottom line.

The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.

I see what he is getting at. There appears to have been fraud at every level. But this, it seems to my judicially untrained eye, is the very loophole the banks need. If everyone knew, as seems likely, and nobody blew the whistle, which is clear in retrospect, then these practices were common. If they were common, then they were not criminal. The government knew, and the government did nothing. Ditto for the Federal Reserve, the Comptroller of the Currency, and every other regulatory agency – Federal, state, and local.

When a criminal conspiracy acts in a criminal fashion, it can be prosecuted. But when a criminal conspiracy has been licensed by the government, and has de facto run the government of every major nation for a century, it will be difficult to get a conviction. None dare call it criminal.

Mr. Olender is correct in his observation regarding the magnitude of this economic liability.

The problem isn't just subprime loans. It is the entire mortgage market. As home prices fall, defaults will rise sharply – period. And so will the patience of mortgage bondholders. Different classes of mortgage bonds from various risk pools are owned by different central banks, funds, pensions and investors all over the world. Even your pension or 401(k) might have some of these bonds in it.

This is the domino effect. The subprime mess cannot be contained. It is like an untreated cancer cell. It will spread.

Mr. Olender means well, but he suffers from an affliction that is almost universal where the banking system is involved: terminal naïveté.

Perhaps some U.S. government department can make veiled threats to foreign countries to suggest they will suffer unpleasant consequences if their largest holders (central banks and investment funds) don't go along with the plan, but how could it be possible to strong-arm everyone?

How? The same way the Bank of England and Parliament have been strong-arming the British since 1694. If you were to identify the longest-running, most successful example of political strong-arming in modern history, you could do no better than to study the Bank of England's relationship with Parliament.

This example is today universal. Every nation on earth has a central bank except Andorra and Monaco. Monaco has a casino instead. Andorra has sheep, but at least only the sheep get sheared. It is different for the rest of us.

What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back. The time to look into this is before the shredders have worked their magic – not five years from now.

What would be even more prudent and even more logical would be to abolish central banking. But the world is neither prudent nor logical when it comes to fractional reserve banking and the bubbles it creates.

Yet this bubble is like no other in my lifetime. It is tied to housing, and the entire Western world has been affected. The home-owning masses feel rich because their homes have risen in price. Why has this happened? Because buyers of houses just one price range down have sold and want to move up. Houses are rising because suckers at the bottom were lured into preposterous loans. I don't mean the home buyers, who got in with no money down. I mean the suckers who lent them the money.

Here is why the government is getting in. If the government bails out the new homeowners, it baptizes the entire procedure retroactively.

The goal of the freeze may be to delay bond investors from suing by putting off the big foreclosure wave for several years. But it may also be to stop bond investors from suing. If the investors agreed to loan modifications with the "real" wage and asset information from refinancing borrowers, mortgage originators and bundlers would have an excuse once the foreclosure occurred. They could say, "Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!"

This is what the freeze bill all about. It is going to sail through Congress. The President will sign it. As soon as it's law, the banks are far safer than before. There may be lawsuits, but judges will know where their bread is buttered.

Mr. Olender goes on to name names and identify culprits. Here, I have decided not to follow his lead.

CONCLUSION

The economic losses are gigantic and will grow. The trickle of bad news is going to become a flood over the next year. It will wear down the resistance of perma-bulls, who believe that the Federal Reserve can save the day and save the stock market. All over the world, the repercussions of bad loans, carry-trade leverage, and relatively tight money are going to be felt.

This has been a huge pool of investment errors. This has sucked in the best and the brightest people on earth, those who allocate capital. They trusted Alan Greenspan. They trusted artificially low interest rates. They trusted fiat money. That trust has been betrayed, as always. But this time, it has been betrayed on a scale that puts the world's banking system at risk.

The bailouts have only just begun.

December 19, 2007

[Guest David Guyatt]

This has been a huge pool of investment errors. This has sucked in the best and the brightest people on earth, those who allocate capital. They trusted Alan Greenspan. They trusted artificially low interest rates. They trusted fiat money. That trust has been betrayed, as always. But this time, it has been betrayed on a scale that puts the world's banking system at risk.

"Trust" and "trusted" are not, in my experience anyway, concepts that the banking community give much value to. "Make hay when the sun shines", yes. "Rake it in when no one is watching", yes.

But not "trust".

The word was long ago, surgically removed from the bankers lexicon.

[Douglas Caddy]

This has been a huge pool of investment errors. This has sucked in the best and the brightest people on earth, those who allocate capital. They trusted Alan Greenspan. They trusted artificially low interest rates. They trusted fiat money. That trust has been betrayed, as always. But this time, it has been betrayed on a scale that puts the world's banking system at risk.

"Trust" and "trusted" are not, in my experience anyway, concepts that the banking community give much value to. "Make hay when the sun shines", yes. "Rake it in when no one is watching", yes.

But not "trust".

The word was long ago, surgically removed from the bankers lexicon.

Crisis may make 1929 look a 'walk in the park'

Last Updated: 11:02pm GMT 23/12/2007

Page 1 of 3

Telegraph (U.K.)

December 23, 2007

http://www.telegraph.co.uk/money/main.jhtm...cccrisis123.xml

As central banks continue to splash their cash over the system, so far to little effect, Ambrose Evans-Pritchard argues things are rapidly spiralling out of their control

Twenty billion dollars here, $20bn there, and a lush half-trillion from the European Central Bank at give-away rates for Christmas. Buckets of liquidity are being splashed over the North Atlantic banking system, so far with meagre or fleeting effects.

•As the credit paralysis stretches through its fifth month, a chorus of economists has begun to warn that the world's central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.

"Liquidity doesn't do anything in this situation," says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression.

"It cannot deal with the underlying fear that lots of firms are going bankrupt. The banks and the hedge funds have not fully acknowledged who is in trouble. That is the critical issue," she adds.

Lenders are hoarding the cash, shunning peers as if all were sub-prime lepers. Spreads on three-month Euribor and Libor - the interbank rates used to price contracts and Club Med mortgages - are stuck at 80 basis points even after the latest blitz. The monetary screw has tightened by default.

York professor Peter Spencer, chief economist for the ITEM Club, says the global authorities have just weeks to get this right, or trigger disaster.

"The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are allowing the money markets to dictate policy. We are long past worrying about moral hazard," he says.

"They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don't think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park," he adds.

The Bank of England knows the risk. Markets director Paul Tucker says the crisis has moved beyond the collapse of mortgage securities, and is now eating into the bedrock of banking capital. "We must try to avoid the vicious circle in which tighter liquidity conditions, lower asset values, impaired capital resources, reduced credit supply, and slower aggregate demand feed back on each other," he says.

New York's Federal Reserve chief Tim Geithner echoed the words, warning of an "adverse self-reinforcing dynamic", banker-speak for a downward spiral. The Fed has broken decades of practice by inviting all US depositary banks to its lending window, bringing dodgy mortgage securities as collateral.

Quietly, insiders are perusing an obscure paper by Fed staffers David Small and Jim Clouse. It explores what can be done under the Federal Reserve Act when all else fails.

Section 13 (3) allows the Fed to take emergency action when banks become "unwilling or very reluctant to provide credit". A vote by five governors can - in "exigent circumstances" - authorise the bank to lend money to anybody, and take upon itself the credit risk. This clause has not been evoked since the Slump.

Yet still the central banks shrink from seriously grasping the rate-cut nettle. Understandably so. They are caught between the Scylla of the debt crunch and the Charybdis of inflation. It is not yet certain which is the more powerful force.

America's headline CPI screamed to 4.3 per cent in November. This may be a rogue figure, the tail effects of an oil, commodity, and food price spike. If so, the Fed missed its chance months ago to prepare the markets for such a case. It is now stymied.

This has eerie echoes of Japan in late-1990, when inflation rose to 4 per cent on a mini price-surge across Asia. As the Bank of Japan fretted about an inflation scare, the country's financial system tipped into the abyss.

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