Re: SC80

http://www.informationclearinghouse.info/article21087.htm

Down For The Count

"The whole system is contracting"

There are signs that the credit crunch is easing. Interbank lending in dollars has fallen for a ninth straight day. The various indicators of stress in the market--Libor, the TED spread, and the Libor-OIS spread--are all gradually returning to normal, but the damage to the broader economy has been substantial. Major corporations have had to stretch their credit lines just to get the money they need to cover routine operating expenses and a lot of retailers have not been able to get funding for their inventories for the holiday season, so they'll either have to hire fewer workers or simply shut their doors for Christmas. Also, corporate defaults have increased as businesses have been unable to turn over their short-term debt. According to Fitch Ratings, the "crisis will cut growth in credit this year by 50 percent as financial firms reduce leverage, investors' appetite for risk declines, and the worldwide economy slows." When credit is less available, there's less business activity and the economy slows. Unemployment goes up and quarterly earnings go down. It's a vicious circle that starts with speculation and ends in panic. The financial system has to reestablish its equilibrium by purging the excessive credit that developed through low interest rates and lax lending standards. Financial institutions everywhere are in the process of deleveraging which is putting downward pressure on the main stock indexes and creating turmoil in the currency markets.

The US Treasury and Federal Reserve are now underwriting the entire financial system. The free market has been abandoned altogether. Everything from commercial paper to money markets is now backed by the "full faith and credit of the United States". Without that explicit government guarantee, the credit markets would still be frozen and the system would crash. But government guarantees do not address the real problem, which is toxic assets that must be accounted for and written down. All it does is take hundreds of billions of dollars in mortgage-backed garbage onto the nation's balance sheet and undermine the creditworthiness of the United States. Eventually, foreign central banks will see the folly of this maneuver and refuse to buy more US debt. When that happens, there will be a run on the dollar and a major dislocation in the bond market. Then, the financial system will grind to a standstill once again.

Secretary of the Treasury Henry Paulson's $125 billion capital "giveaway" to nine of the country's largest banks has helped to calm the credit markets, but it won't last. The "real economy" is beginning to stumble and the stock market is gyrating more wildly than anytime in history. Wall Street is consumed with fear and investors are ducking out the exits as fast as their feet will carry them. According to the New York Times, the banks probably won't even use Paulson's money to extend loans to consumers and businesses (as intended), but will hoard it to make sure they are sufficiently capitalized when their mortgage-backed assets are downgraded. Even worse, the banks may use the money to gobble up smaller local and regional banks. On Tuesday's Jim Lerher News Hour, New York Times journalist Andrew Ross Sorkin put it like this: "The other thing that some of them may do with that money is go out and make acquisitions and buy other banks, (which) means that you will not be getting this money into your pocket anytime soon....I think the larger issue is the economy and these banks, in terms of lending, are not going to start lending real money until the economy turns."

Paulson knows what the banks are up to; after all, these are his friends. The truth is, the $125 billion was not given to the banks to soften the effects of the recession or increase lending. It was given to make the strong banks even stronger so they could monopolize the industry. Paulson's real plan is "more consolidation" and less competition, or as economist Michael Hudson says, "Big fish eat little fish". The Treasury Secretary is using his authority to reward his friends rather than doing what is best for the country.

In the last few weeks, the broader economy has deteriorated faster than anytime in the last 70 years. That's why Fed chief Ben Bernanke has given the nod to another stimulus package of $150 to $300 billion dollars. The gears are rusting in place and the desperation in Washington is palpable. Calculated Risk web site provided a transcript of a conference call by MSC Industrial Supply (MSC) which summed up the prevailing mood in today's business world:

MSC: “In the last several weeks, customers' sentiment has turned dramatically downwards. Here are a few of the things we have recently heard and I'll quote a few of them. One quote is our new orders are down substantially in the last few weeks. Another is that corporate has told us to reduce inventory. What we have also heard is make due with what you have. And finally, another quote is capital expenditures are on hold. Customers are concerned about the economy and the lack of available credit. They're reducing inventories, orders, and order size and there has been a trend toward deferring capital expenditures..."

MSC: "David, we view this time as unprecedented in history. The economy is undergoing a huge change, how that is going to shake out all remains to be seen, but I think what is important to know is it's a huge change that, frankly, no one had a chance to see coming, so we than specifically in our customer base there is a tremendous amount of fear that is gripping customers and evidenced by what we have seen the last couple of weeks in October, almost buying paralysis, that is really the way that we think about it, and frankly, in speaking with so many customers what we see happening.... What is has happened here with the credit crisis is while the economy was by no means booming, it was kind of rolling along and we almost think that what typically would have taken six, seven, eight, 9, 12 months to start to come down happened almost literally overnight." (Calculated Risk)

Events are now unfolding so quickly, they're impossible to follow. But this much is clear, the wheels have fallen off the cart. The Fed has lost control of the system. On Monday, Bernanke announced the creation of the Money Market Investor Funding Facility (MMIFF), which will provide $550 billion in liquidity to U.S. money market investors. It is another in a long list of steps to try to provide liquidity to a system that is burning through trillions of dollars of credit via the deleveraging of hedge funds and asset downgrades. Of course, the Fed does not really have the money it has committed. It will have to expand its balance sheet, issue more Treasurys, and hope that foreign central banks do not see that the US financial system is headed for the rocks.

"It is essential we preserve the foundations of democratic capitalism,'' Bush bellowed on Monday.

All that's left of the free market is the threadbare rhetoric of our lame duck President. The world's biggest creditor is now the most ardent defender of market fundamentalism.

Last week, banks borrowed a record $437 billion per day, topping the previous week's $420 billion per day a week earlier. Hundreds of banks cannot meet their capital requirements without regular low interest loans from the Federal Reserve. The banking system is in shambles. The FDIC needs to determine which banks can be saved and which need to be shut down, otherwise the insolvent banks will use the money they get from the Treasury on risky bets to dig their way out of bankruptcy. Without restrictions on how they can issue credit, many of the banks will engage in the same reckless behavior and speculation that brought on the current calamity..........

........... The actions of the Fed, the Treasury and the FDIC are likely to cost in excess of $2 trillion. That does not include the trillions in market capitalization that are wiped out by plummeting home and stock prices. Nor does it include the incalculable suffering from rising unemployment, falling living standards, and personal hardship. Eventually, the Fed's emergency measures will result in higher taxes, soaring deficits and slower growth. As America's "consumer-based" economy flags and the recession deepens, capital will flee US Treasurys and securities and create a funding crisis. This may be hard to imagine now that the dollar is strengthening and US Treasurys appear to be in great demand, but the handwriting is already on the wall..........

...........The Fed now faces the daunting task of trying to maintain America's dominant place in the global system while the economy contracts, deficits skyrocket and the pillars of US-style capitalism come crashing to earth.