Signs of the Economic Apocalypse, 9-15-08

From SOTT.net:

Gold closed at 768.70 dollars an ounce Friday, down 4.4% from $802.80 for the week. The dollar closed at 0.7032 euros Friday, up 0.3% from 0.7009 at the close of the previous week. That put the euro at 1.4221 dollars compared to 1.4267 the week before. Gold in euros would be 540.54 euros an ounce, down 4.1% from 562.70 at the close of the previous Friday. Oil closed at 100.69 dollars a barrel Friday, down 5.5% from 106.23 at the end of the week before. Oil in euros would be 70.80 euros a barrel, down 5.2% from 74.46 for the week. The gold/oil ratio closed at 7.63 Friday, up 0.9% from 7.56 at the end of the week before. In U.S. stocks, the Dow Jones Industrial Average closed at 11,421.99 Friday, up 1.8% from 11,220.96 at the close of the previous Friday. The NASDAQ closed at 2,261.27 Friday, up 0.2% from 2,255.88 at the close of the week before. In U.S. interest rates, the yield on the ten-year U.S. Treasury note closed at 3.72%, up 2 basis points from 3.70 for the week.

One week after the takeover of Fannie Mae and Freddie Mac by the Fed, the financial giants on the verge of collapse are Lehman Brothers, Merrill Lynch and Washington Mutual. No one seems to know where the bottom is. Even the New York Times is nervous:

In Frantic Day, Wall Street Banks Teeter

Andrew Ross Sorkin

September 15, 2008

In one of the most dramatic days in Wall Street’s history, Merrill Lynch agreed to sell itself to Bank of America for roughly $50 billion to avert a deepening financial crisis, while another prominent securities firm, Lehman Brothers, hurtled toward liquidation after it failed to find a buyer, people briefed on the deals said.

The humbling moves, which reshape the landscape of American finance, mark the latest chapter in a tumultuous year in which once-proud financial institutions have been brought to their knees as a result of tens of billions of dollars in losses because of bad mortgage finance and real estate investments.

They culminated a weekend of frantic around-the-clock negotiations, as Wall Street bankers huddled in meetings at the behest of Bush administration officials to try to avoid a downward spiral in the markets stemming from a crisis of confidence.

“My goodness. I’ve been in the business 35 years, and these are the most extraordinary events I‘ve ever seen,” said Peter G. Peterson, co-founder of the private equity firm the Blackstone Group, who was head of Lehman in the 1970s and a secretary of commerce in the Nixon administration.

It remains to be seen whether the sale of Merrill, which was worth more than $100 billion during the last year, and the controlled demise of Lehman will be enough to finally turn the tide in the yearlong financial crisis that has crippled Wall Street. Questions remain about how the market will react Monday, particularly to Lehman’s plan to wind down its trading operations, and whether other companies may still falter, like the American International Group, the large insurer, and Washington Mutual, the nation’s largest savings and loan. Both companies’ stocks fell precipitously last week.

Though the government took control of the troubled mortgage finance companies Fannie Mae and Freddie Mac only a week ago, investors have become increasingly nervous about the difficulties of major financial institutions to recover from their losses.

How things play out could affect the broader economy, which has been weakening steadily as the financial crisis has deepened over the last year, with unemployment increasing as the nation’s growth rate has slowed.

What will happen to Merrill’s 60,000 employees or Lehman’s 25,000 employees remains unclear. Worried about the unfolding crisis and its potential impact on New York City’s economy, Mayor Michael R. Bloomberg canceled a trip to California to meet with Gov. Arnold Schwarzenegger. Instead, aides said, Mr. Bloomberg spent much of the weekend working the phones, talking to federal officials and bank executives in an effort to gauge the severity of the crisis.

The weekend that humbled Lehman and Merrill Lynch and rewarded Bank of America, based in Charlotte, N.C., began at 6 p.m. Friday in the first of a series of emergency meetings at the Federal Reserve building in Downtown Manhattan.

The meeting was called by Fed officials, with Treasury Secretary Henry M. Paulson Jr. in attendance, and it included top bankers. The Treasury and Federal Reserve had already stepped in on several occasions to rescue the financial system, forcing a shotgun marriage between Bear Stearns and JPMorgan Chase this year and backstopping $29 billion worth of troubled assets — and then agreeing to bail out Fannie Mae and Freddie Mac.

The bankers were told that the government would not bail out Lehman and that it was up to Wall Street to solve its problems. Lehman’s stock tumbled sharply last week as concerns about its financial condition grew and other firms started to pull back from doing business with it, threatening its viability.

Without government backing, Lehman began trying to find a buyer, focusing on Barclays, the big British bank, and Bank of America. At the same time, other Wall Street executives grew more concerned about their own precarious situation.

The fates of Merrill Lynch and Lehman Brothers would not seem to be linked; Merrill has the nation’s largest brokerage force and its name is known in towns across America, while Lehman’s main customers are big institutions. But during the credit boom both firms piled into risky real estate and ended up severely weakened, with inadequate capital and toxic assets.

…The weekend’s events indicate that top officials at the Federal Reserve and the Treasury will take a harder line on providing government support of troubled financial institutions.

While offering to help Wall Street organize a shotgun marriage for Lehman, both the Fed chairman, Ben S. Bernanke, and Mr. Paulson had warned that they would not put taxpayer money at risk simply to prevent a Lehman collapse.

The tough-love message was a major change in strategy, but it remained unclear until at least Friday whether the approach was real or just posturing. If the Fed was faced with the genuine risk of another market meltdown, analysts said, it would be almost duty-bound to ride to a rescue of one kind or another.

What few people anticipated was that the Treasury and Fed officials might reach for an even broader strategy.

“They were faced after Bear Stearns with the problem of where to draw the line,” said Laurence H. Meyer, a former Fed governor who is now vice chairman of Macroeconomic Advisors, a forecasting firm. “It became clear that this piecemeal, patchwork, case-by-case approach might not get the job done.”

At first glance, the new strategy by Mr. Paulson and Mr. Bernanke represents a much purer and tougher insistence that Wall Street work out its own problems without government help.

But that is only the first glance. If Bank of America acquired Merrill Lynch, its capital reserves would immediately fall below the minimum requirements for bank holding companies. Federal regulators, including the Federal Reserve, would have to show lenience for as long as it took the capital markets to regain their confidence — which could be quite a while.

And Merrill Lynch is hardly the only troubled financial institution on the horizon. Administration officials acknowledged this week that more bank failures were inevitable, and the main protection for depositors — the Federal Deposit Insurance Corporation — is likely to exhaust the reserves it has built over the years from bank insurance premiums.

“What we need now is a systemic solution and to admit that this is an extraordinary situation,” Mr. Meyer said. He said the government should go to the heart of the crisis — the mortgage market — and start buying mortgage-backed securities in a broad rescue.

That is similar to an approach urged by Alan Greenspan, Mr. Bernanke’s predecessor as chairman of the Federal Reserve. Mr. Greenspan, who has long been a staunch opponent of government intervention in the economy, said Sunday that the federal government might have to shore up some financial institutions.

“This is a once-in-a-half-century, probably once-in-a-century type of event,” Mr. Greenspan said in an interview on ABC. “I think the argument has got to be that there are certain types of institutions which are so fundamental to the functioning of the movement of savings into real investment in an economy that on very rare occasions — and this is one of them — it’s desirable to prevent them from liquidating in a sharply disruptive manner.”

Most economists say that bailouts are often bad economic policy because each rescue tends to encourage “moral hazard” — the tendency of institutions and investors to take even bigger risks because they assume the government will rescue them, too.

Both Mr. Paulson and Mr. Bernanke worried that they had already gone much further than they had ever wanted, first by underwriting the takeover of Bear Stearns in March and by the far bigger bailout of Fannie Mae and Freddie Mac.

Officials noted that Lehman’s downfall posed a lower systemic threat because it had been a very visible and growing risk for months, which meant that its customers and trading partners had had months to prepare themselves.

Outside the public eye, Fed officials had acquired much more information since March about the interconnections and cross-exposure to risk among Wall Street investment banks, hedge funds and traders in the vast market for credit-default swaps and other derivatives.

But James Leach, a former Republican congressman from Iowa and chairman of the House Banking committee, said the Fed and Treasury might not be able to avoid a broader rescue.

“The Fed’s historic position is to object philosophically to a rescue role but in the end to do everything in its power to avoid anything that poses systemic risk,” said Mr. Leach, now a lecturer at Harvard.

“My sense is that the systemic question will be the only question on the table if Lehman falters,” he continued. “If systemic risk is considered grave, the Fed, perhaps with Treasury playing at least an advisory role, will intervene.”

Andrew Leonard reminds us that earlier this year failing firms got bailed out by “sovereign wealth funds” controlled by sheikdoms. Now no one but the Federal Reserve is willing to step in:

Rest of world to Wall Street: Not this time

Andrew Leonard

Friday, Sept. 12, 2008

Not so long ago, when Wall Street's best and brightest investment banks first started reeling from the credit crunch, sovereign wealth funds from around the world came riding to the rescue. Need to shore up your bottom line after a few billion dollars worth of write-downs? The Abu Dhabi Investment Authority or Singapore's Temasek Holdings were here to help.

In January, in "How Wall Street Broke The Free Market," I wrote about how both the left and right in the United States were wringing their hands at the prospect of foreign governments buying such big stakes in elite American financial institutions.

Not too worry! Eight months later, reports the Wall Street Journal in a big page one story (warning, ominously, that the credit crisis "could be entering a critical stage,") foreign governments aren't so eager to spring to the aid of beleaguered Americans.

Stung by mammoth losses on those investments, many investors are now balking. Sovereign-wealth funds, many of them facing criticism at home over the investments, have stayed on the sideline as Lehman and other firms have struggled to raise capital.

So what's worse -- getting bailed out by authoritarian petro-states, or being deemed too shaky an investment to be worth the trouble?

Raising adequate capital to weather the credit crunch storm is getting tougher and tougher for everybody, including commercial banks such as Washington Mutual, reports the Journal. Not only are foreign investors getting skittish, but some potential local white knights are running into problems. Private equity firms, for example, are limited to ownership of no more than 25 percent of a deposit-taking financial institution before they must be considered a bank-holding company subject to federal regulation.

Executives from such firms as Carlyle Group and Blackstone Group have been using the credit crunch to lobby the Office of Thrift Supervision and the Federal Reserve to allow them to own bigger stakes of financial firms without having to face regulation.

That's a good one. Because clearly the answer to Wall Street's problems over the last year is less regulation.

Since wealthy sheikdoms won’t bail out failing U.S. financial firms, and since the past weekend’s events have signalled that the U.S. Federal Reserve can’t keep doing this, banks are going to have to start bailing each other out, either by a healthier one buying up an unhealthy one, or by creating a bailout pool:

Banks roll out $70 billion loan program

Joe Bel Bruno, AP Business Writer

September 14, 2008

NEW YORK - A group of global banks and securities firms announced late Sunday a $70 billion loan program that financial companies can tap to help ease a credit shortage that threatens global financial markets.

The ten banks, which include JPMorgan Chase & Co. and Goldman Sachs Group Inc., said they were committing $7 billion each for the pool. The pool would act as a signal to the marketplace that banks, brokerages, and other financial companies can lean on the fund to take care of borrowing needs.

The banks said the program will be available to participating banks which can get a cash infusion up to a maximum of one-third of the total size of the pool. The size of the loan program might increase as "other banks are permitted to join."

All participating banks intend to use this facility beginning this week, the statement said.

The banks also include Bank of America Corp., Barclays PLC, Citigroup Inc., Credit Suisse Group, Deutsche Bank AG, Merrill Lynch & Co., Morgan Stanley and UBS.

The banks made the announcement to try to head off market disruptions after the possible failure of investment bank Lehman Brothers Holdings Inc. Lehman was expected to file for bankruptcy by Monday after succumbing to dwindling investor confidence due to losses from its real estate holdings.

What are we to make of all this? For one thing, an era is ending. The era of neoliberal “financial innovation” or new, complex ways of parasitically funelling wealth up the pyramid is coming to an end. So, too, is the era of U.S. hegemony.

US bailout of mortgage giants sets stage for wider financial crisis

Barry Grey

12 September 2008

Since the Bush administration announced on Sunday the US government takeover of mortgage finance giants Fannie Mae and Freddie Mac, in the largest corporate bailout in American history, developments have underscored the profound and systemic nature of the crisis that precipitated the action.

A week of wild gyrations on US stock markets, fueled by fears of an impending collapse of the Wall Street investment bank Lehman Brothers and the country’s largest savings and loan bank, Washington Mutual, demonstrates that the rescue of the government-sponsored mortgage companies is a stop-gap measure that does not begin to resolve the underlying crisis of American capitalism.

On the contrary, the bailout of Fannie Mae and Freddie Mac sets the stage for an intensification of the crisis in the coming months. At heart, the demise of the mortgage firms, which account for 80 percent of new home mortgages in the US and have a combined liability of $5.3 trillion in mortgage-backed securities which they own or guarantee, is a result of the collapse of the colossal credit bubble which sustained the super-profits of US banks and investment firms and the seven- and eight-figure salaries of their top executives.

It is the product of an economic system that has increasingly based itself on speculation and various forms of economic parasitism, while gutting the productive base of the country—at the cost of millions of jobs and the living standards of the American working class.

The decay of American capitalism has produced an economy that is drowning in debt and is dependent on massive inflows of capital from abroad for its survival. Now, the assumption by the government of the debt of the mortgage companies, carried out to protect the financial interests of banks and big investors, has placed a question mark over the solvency of the US government itself.

This threatens a curtailment of the inflow of international capital, a further erosion in the status of the US dollar and a drastic increase in the interest paid by the government to borrow money from its creditors. The US is already by far the world’s biggest debtor nation, with a balance of payments deficit of $800 billion and an economy that is sustained by a yearly inflow of $1 trillion in overseas capital.

The quantum leap in the national debt and government budget deficits resulting from the bailout of Fannie Mae and Freddie Mac—and the further corporate bailouts that are all but certain to follow—must inevitably lead to a realignment of social conditions within the US in accordance with the actual, deeply eroded, position of the United States in the world economy. This means an even more drastic lowering of the living standards of the American people.

On Tuesday, the Congressional Budget Office (CBO) declared that as a result of the government bailout, the finances of Fannie Mae and Freddie Mac had to be “directly incorporated into the federal budget,” and its liabilities added to the US national debt. This means, in effect, a near doubling of the US sovereign debt to a figure equivalent to the country’s gross domestic product (GDP).

The Financial Times reported Wednesday that the bailout had already resulted in a sharp rise in the price of credit default swaps on five-year US government debt. Credit default swaps are private contracts to buy insurance against the default of various forms of debt.

As the Financial Times wrote, “... the price suggests the market believes the US government is more likely to default on its obligations than some other industrialised countries.” It went on to cite a credit research strategist as saying, “The USA is now ‘riskier’ than Norway, Germany, Netherlands, Sweden, Finland, Austria, France, Denmark, Quebec and Japan.”

The CBO statement on Fannie Mae and Freddie Mac accompanied its report on the US government budget deficit for the current fiscal year, which ends September 31, and its projections for fiscal 2009 and beyond. The CBO put the current deficit at $407 billion, more than double the $161 billion deficit for fiscal 2007.

It projected, on the basis of current tax laws, that the budget gap would rise to a record $438 billion in the 2009 fiscal year that begins October 1. However, as CBO Director Peter Orszag noted, that figure could easily climb to $540 billion if Congress acts in the coming months, as expected, to curtail the growth in the alternative minimum tax and extend a variety of expiring business tax breaks.

Orszag further noted that these figures did not take into account the full scale of government expenditures related to the bailout of Fannie Mae and Freddie Mac. Treasury Secretary Henry Paulson said on Sunday the government would commit up to $200 billion to prop up the companies. Given the continuing decline in home prices and rise in foreclosures, that figure is virtually certain to rise by tens, if not hundreds, of billions.

Orszag said that the deficit would remain at between 3 and 4 percent of the GDP for the next decade, resulting in a $7 trillion rise in the national debt. Even these dire projections assume that Bush’s massive tax cuts for the rich will not be extended beyond their scheduled expiration in 2010.

Significantly, Orszag pointed to government health care spending—not the cost of corporate bailouts or the wars in Iraq and Afghanistan (which have to date consumed a combined sum of $850 billion)—as the main source of exploding deficits going forward. The CBO warned that Medicare and Medicaid spending, which currently account for an estimated 4.6 percent of GDP, could account for up to 12 percent of GDP by 2050.

The mounting financial crisis of American capitalism was further underscored by the Commerce Department’s report Thursday on the US trade deficit, which surged in July by 5.2 percent to $62.2 billion, the highest level in 16 months.

The headlong rush of Lehman Brothers and Washington Mutual toward collapse—or new federal bailouts—within days of the government takeover of Fannie Mae and Freddie Mac has underscored the depth of the financial crisis.

The stock of the 158-year-old Wall Street investment bank collapsed this week after it was reported that Lehman’s efforts to secure a capital infusion from the state-owned Korea Development Bank had collapsed. At the close of the financial markets on Thursday, the value of Lehman’s stock—down by more than 90 percent since its peak last February—was about $2.9 billion. It stood at $37.2 billion at the start of 2008.

Once the biggest underwriter of mortgage-backed securities, the firm has seen its speculative investments collapse and would have already gone bankrupt were it not for the Federal Reserve’s decision, taken at the time of the government-subsidized sale of Bear Stearns to JP Morgan Chase last March, to extend low-cost loans to investment banks and accept virtually worthless mortgage-related securities in return for highly rated Treasury securities.

It was reported Thursday that the firm was in talks with potential buyers, including Bank of America, for a buyout that would avoid bankruptcy or a government bailout—at the cost of billions in losses to shareholders and the jobs of thousands of Lehman employees. On Wednesday, when it announced a third quarter loss of $3.9 billion and a plan to spin off much of its business and shrink its operations, the company said it was slashing 1,000 to 1,500 jobs, its fourth round of layoffs this year.

Over the past year, US banks and brokerages have cut more than 110,000 jobs.
The collapse of both Lehman and the two government-sponsored mortgage giants starkly illustrates the immense dependence of American capitalism on overseas capital. Lehman went to ground after its bid for funds from a South Korean bank failed, and the government bailout of Fannie Mae and Freddie Mac was precipitated by the dumping of the firms’ securities by central banks and major investors in Asia and Russia.

The stock of the giant savings and loan bank Washington Mutual, which has some $180 billion in mortgage-related loans, has fallen by 34 percent since Monday and 92 percent over the past year. This week it reported a $3.33 billion second quarter net loss and has said its mortgage losses could reach $19 billion through 2011.

Raising the possibility of another government bailout, Christopher Whalen, a managing partner at Institutional Risk Analytics, said of Washington Mutual, “If this goes on until the end of the year, the bank is either going to have to be sold or recapitalized by the government. Those are the only choices.”

The Financial Times on Wednesday worried that the massive US budget deficits were limiting the ability of the government to continue propping up Wall Street with injections of hundreds of billions in capital. It wrote:

“Yesterday’s new deficit projections by the Congressional Budget Office highlight the troubled state of US government finances as it embarks on a new stage of interventions to contain the chronic impact of the credit crisis....

“Some economists worry that as the Federal Reserve has spent much of its ammunition, and as fighting the credit crisis falls more to the government, weak public finances mean the government does not have unlimited ammunition either.”

Noting that the Federal Reserve was seeking to conserve its capital for further corporate bailouts, the newspaper wrote, “Many Fed officials share this view, which is why the Fed is lukewarm on further fiscal stimulus, preferring to see the limited government funds spent on shoring up the financial system.”

The response to mushrooming budget deficits and soaring national indebtedness, as well as the spreading crisis on Wall Street, by the next administration, whether headed by Republican John McCain or Democrat Barack Obama, will be a policy of brutal austerity directed against the working class.

One can safely predict that not long after the November election, the incoming president will announce that his transition advisers have shown him the country’s financial books, that the dire state of the nation’s economy makes inoperative any and all promises of health care reform or relief to distressed homeowners, and that a regime of discipline and “sacrifice” will have to be imposed in the “national interest.”

Senator Kent Conrad, the Democratic chairman of the Senate Budget Committee, sounded just such a note when he said, in response to the CBO report, that “the next president will be inheriting a budget and economic outlook that is far worse than most people realize.”

As the CBO report indicates, the next administration will be tasked with dismantling basic entitlement programs such as Medicare and Medicaid.

If the demise of the U.S. empire happens in an orderly fashion, it would be an unalloyed Good Thing. Such things hardly ever happen smoothly, however. There will be increasing temptation for the Empire’s leaders to place an all or nothing bet, to go “all in” in poker terminology. Especially now that the Empire’s opponents are openly thumbing their noses at the U.S. Look at what has happened just in the past month. The United States (and Israel) egged its ally in the Caucasus, Georgia, to attack Russian-controlled territory. Russia inflicted a crushing defeat on U.S. and Israeli military hardware, software and personnel (yes, even personnel). The United States then launched illegal attacks in Pakistani territory. In its so-called “backyard” (what an insulting term!) in Latin America, the U.S. Ambassador to Bolivia began to coordinate a coup against Evo Morales and Bolivia expelled the Ambassador. The U.S. threatened Bolivia, but who believes them anymore? Venezuela then also ordered the U.S. Ambassador to leave, after earlier in the week inviting Russia to deploy two strategic bombers (“strategic” means they can carry nuclear weapons).

What will the world be like in a month or two?