Defaulting banks - where will it stop?

[Jan Klimkowski]

It seems the Fed is genuinely out of money, is levered at 50:1, and is currently engaged in "kiting" - aka counterfeiting or pass the parcel & hope the music doesn't stop when you're holding it....

Karl Denninger's latest analysis:

Yes We Will (Have A Depression)

The mainstream media is finally starting to figure it out.

In Barrons "Other Voices" column for publication on Monday we have this:

NOW WE CAN SEE THAT THE ECONOMY IS A CONFIDENCE GAME. With markets spinning out of control and liquidity frozen, analysts and commentators repeat again and again that the problem is that investors have lost confidence. What they don't adequately stress is that this loss of confidence is fully justified.

In the past several decades, financial markets have become a sophisticated confidence game, and the people in the markets are latter-day versions of Herman Melville's wily character in The Confidence-Man, duping passengers floating down the nation's great artery, the Mississippi River, on the paddle-steamer Fidèle. (Melville's novel, appropriately, takes place on April Fool's Day.)

.....

The world Melville imagined more than 150 years ago has become a reality today. In the microcosm of the Fidèle, devious con men prey on credulous victims, who no longer know what is real and what is not.

Although the disguises have changed, the game has not. When values-financial, moral and religious-are based on nothing, redemption is impossible. We will not solve our economic problems until we unmask the disingenuous tricksters and reassess values that are not merely financial."

Bloomberg Media is also on the case now with a lawsuit aimed at The Fed:

``The American taxpayer is entitled to know the risks, costs and methodology associated with the unprecedented government bailout of the U.S. financial industry,'' said Matthew Winkler, the editor-in-chief of Bloomberg News, a unit of New York-based Bloomberg LP, in an e-mail.

The Fed has lent $1.5 trillion to banks, including Citigroup Inc. and Goldman Sachs Group Inc., through programs such as its discount window, the Primary Dealer Credit Facility and the Term Securities Lending Facility. Collateral is an asset pledged to a lender in the event that a loan payment isn't made. "

It only took nearly a year and a half from when I started to sound the alarm before the evidence became incontrovertible and the media began to wake up: over a million jobs were lost, the market is down 40% (with a target of down 90% - halfway there on the road to hell!) and unemployment is in the process of skyrocketing.

But the voices calling for "more hiding of the truth!" have not ceased; indeed, the stridency of their screaming has gone parabolic. Chief among them are one of the architects of the lies in the first place, the National Association of Realtors (NAR)'s Lawrence Yun:

Given the sentiment in Washington, and also with a new president coming in, President Obama -- and he has indicated that he is favoring some sort of economic stimulus -- we believe that the stimulus package should be focused on housing because we cannot have solid, sound economic recovery without housing market recovery," Yun said."

Yun then goes on to list yet more ways to lie about value, including interest rate "buydowns" (which in fact just take the money out of your pocket as a taxpayer to pay what comes out of your pocket as a home buyer - and does nothing), making increased "conforming" price limits permanent (again - transferring risk from you to you) and similar nonsense.

Oh, and they're forecasting that home prices will increase in 2009 and 2010.

This is, of course, the same group that had its former economist publish a book which had as its subtitle "Why the housing boom will not bust."

Put NAR firmly in the camp of those who refuse to acknowledge economic facts due to their own twisted self-interest.

Nor shall we exclude Berkshire Hathaway, which reported huge losses - more than a billion - on marks taken against derivatives that Warren called "financial weapons of mass destruction" - just before he wrote some.

Oh, and this is one of Obama's chief economic advisers. You'd think that the man who ran on "Change" would, in fact, be interested in seeing some. Perhaps it was just a slogan.

Put The Federal Reserve in the camp of liars and cheats.

"Previously, the rate on required reserve balances had been set at the average target federal funds rate established by the Federal Open Market Committee (FOMC) over a reserves maintenance period minus 10 basis points. The rate on excess balances had been set as the lowest federal funds rate target in effect during a reserve maintenance period minus 35 basis points. Under the new formulas, the rate on required reserve balances will be set equal to the average target federal funds rate over the reserve maintenance period. The rate on excess balances will be set equal to the lowest FOMC target rate in effect during the reserve maintenance period. These changes will become effective for the maintenance periods beginning Thursday, November 6."

Let's talk about this a second. The EFF, or effective Fed Funds Rate, has traded at 0.23% on average since shortly after the target was lowered to 1%. This is a spread of 75 basis points, roughly.

The "discount" on deposited reserves was 35 basis points.

Therefore, were I a bank I could borrow as much as I wanted at 25 basis points and deposit it as "excess reserves" at The Fed (instead of lending against it) and earn an absolutely risk-free return of 40 basis points.

Who pays the 40 basis points? You, the taxpayer.

What is the change they proposed likely to actually do? Increase the EFF? Probably not. More likely it will increase the amount you, the taxpayer, pay banks to 75 basis points.

This is called a "liquidity trap" and is one of the problems with allowing The Fed to pay interest on reserves - they have a direct line to the Treasury for that money, which of course means that you, the taxpayer, are the one who ends up paying.

Did Congress object to funneling off yet more of your money to the banks where they could (and are) stashing those funds with The Fed instead of lending them out? Oh, Chris Dodd and Barney Frank have made much noise about the Tarp, but have either of them made noise about rescinding the ability of The Fed to pay interest on reserves?

Nope, because, in all probability, they don't understand it - and if they do, they sure as hell are counting on you not understanding how all this works.

Never mind that The Fed has found itself powerless to impact the real economy. Remember that Ben Bernanke, back in September of last year, said that he was lowering interest rates and that monetary policy had a "transmission delay" of six to twelve months.

Well Ben? We're six to twelve months later, and instead of easing the upcoming storm what we've seen is the collapse of two major investment banks, the near-collapse of the largest insurer in the world, and the near-collapse of the two largest mortgage issuers and guarantors.

Never mind General Motors, which now has a negative $60 billion book value.

Behind all of this destruction is the ugly truth expressed in the top article I referenced here - that we have gone from an economy that produces cars, grain and TVs to one that shuffles paper.

The first produces real wealth and allocates some of it to the producers up and down the line.

The second invents wealth that does not exist, and relies on people believing the lies in order to succeed - at least for a little while.

We did the same thing in the 1920s, and we got the consequences in the 1930s.

Now we've done this in the 1990s and 2000s, refusing to take our medicine in the 00-03 timeframe, and since we did it "at least twice as bad" this time around, we should expect that it could easily be worse than the 1930s in response.

Sure, we have people who "get it" more than they did in the 1930s. But what we don't have is leaders, either in The Fed or Government, that are willing to do anything about disclosing the truth - which is that they've been complicit in this entire mess (just as they were in the 1920s) and thus they need to fall on their swords.

The greatest area of danger here is that The Fed is in fact trying to catch not a falling knife but rather a falling piano. The idea that The Fed can prevent a debt deflation of this magnitude is pure folly; even with expanding its balance sheet from $800 billion to over $2 trillion in less than a year and increasing its leverage to 50:1 (as of the most recent Fed report) it pales beside a housing market that has roughly $3 trillion of bad debt to be expunged - and that's just one sector of damage.

Taken in total the debt that must be defaulted in order to restore balance is likely in the $8-10 trillion range in the United States, and The Fed is not limiting its influence-peddling to the US. The swap lines it has opened to places like South Korea are an attempt to prevent debt deflation there from reflecting back into trade and global currencies; when one looks at the global deflationary forces at play one is staggered - they may in fact exceed global GDP (~$50 trillion)

As just one small example of this we have AIG, which Friday "announced" that it is "annoyed" that banks got better terms than it did in the TARP and thus they now want to "renegotiate", desiring to "pledge their MBS" to restructure the loan and/or do a "debt to equity swap" (akin to my "cramdown" in The Genesis Plan.)

Someone's been smoking some damn good stuff over there at AIG.

You see, AIG already pledged all its assets to The Fed to secure the original line of credit. And what did they pledge to get the second line of credit? Who the hell knows - how do you pledge more as collateral than what you have? One must assume that second credit line is in fact unsecured!

This bit of game playing raises all sorts of questions for The Fed and our government, none of which are being asked or answered as of yet, such as:

*
We still don't know what happened to the mysterious NY Fed credit line that went out to Lehman Brothers to settle certain obligations at or about the time they went under. As far as I can tell, it has not been repaid. Where's the money, who got it, and what security is being held against it (if any)?
*
If AIG pledged "all its assets" on the original $80 billion, what did they pledge for their second line of credit? How do you pledge more than you have? And how do you cram down something that is already pledged off as security when you want to "restructure" your deal?

This is kind of like a poker player who goes bust in the casino and troops to the cage to demand another marker; when told that his check is no good he threatens to commit suicide right there and make a hell of a mess that will drive away business unless they give him cash for his worthless paper.

Or we could take GM's case (mentioned above); they are threatening to open up with a tommy gun on the casino patrons before turning the weapon on themselves (in the form of a threatened 2 million jobs to be lost) if they aren't given a gift - it sure as hell isn't a loan if you have negative net worth!

Care to bet on how many other "suicide threats" The Fed and Congress have had presented to them over the last year but we have not been told about (or at least, not with any sort of real disclosure!)

The precipice America stands on is narrowing dramatically and our government and The Fed are chipping away at the rock with jackhammers.

The Fed is essentially kiting and praying that the clock doesn't run out on them - or worse, that someone doesn't hold up the funds "somewhere" long enough to disrupt the chain. In a "kiting" scheme the crook deposits a check into Bank #1 from Bank #2 (which is in fact no good!), then draws the funds on Bank #1 and deposits them in Bank #2 to make the check good that they wrote. This is illegal, by the way, if you're an "ordinary Joe", as you are effectively counterfeiting the money (it doesn't exist in both places at once!) during the time of the float.

But wait! Isn't counterfeiting of credit the entire nexus of the last five years of "financial innovation"?

Yep.

And now we have The Fed continuing the game but on a global grand scale, taking the excess leverage that everyone else had and consolidating it on its own balance sheet. Where we had a few investment banks running at 30:1 leverage, we now have our Fed running at fifty to one!

The Fed is running what amounts to a gigantic kiting scheme where it borrows $500 billion (the "supplemental Treasury program") from various foreign and domestic sources then loans that money out to the same domestic and foreign sources who settle those trades!

As further evidence of this game we have an enormous number of "fails to deliver" in Treasuries. Why would there be a fail to deliver unless the person who sold it doesn't have it? That's the essence of a kiting scheme - you're effectively counterfeiting, because you're writing a draft that you can't settle. This is showing up in the Treasury market, where "fails" reached an aggregate five trillion dollars in October.

If you or I pulled this game we'd be under indictment. Yet this is the essence of the various programs that Treasury and The Fed has put into place - primary dealers take down Treasury supply yet they are, in no small part, recipients of these various alphabet soup financing programs.

That is the definition of kiting folks. Go look it up.

Why doesn't Congress - or our President-Elect Obama - get out in front of this and stop it?

For one, 99.9% of Americans don't understand it. Many people "kite" checks unknowingly, or at least did before the advent of near-instantaneous electronic clearing. How many people used to go to the grocery store on Thursday night knowing they would be paid Friday, and write a check for groceries that they knew was no good until Friday morning?

Lots. In fact, most people don't even understand that this is against the law because it is in fact counterfeiting the credit (money) that you are allegedly paying the store with.

The Fed (from its balance sheet) can be demonstrated to have about $1 trillion out in loans. Bank lending is actually way up - it is not collapsing.

So where did the loans go?

To other banks and "shadow" financial entities (hedge funds, etc), back and forth, kiting the money while chewing off little bits here and there for their own salvation such as the excess reserve interest payments, all of which is being charged back to you, the taxpayer.

Paulson's TARP (in its various forms, including its original design) makes it worse; in addition to kiting funds back and forth the TARP makes possible the exchange of Treasuries (money good) for trash (MBS and other "assets" that are worth fractions of a dollar.) Bluntly, what Paulson is doing is taking your money and giving it to the banks at a discount (based on whatever they tender to him) who then loan it to you at interest.

Perhaps Obama (or Paulson) can explain exactly how is it beneficial to the economy to:

*
Take capital (your tax receipts) from you and instantly devalue it by whatever the real value of those MBS and other "assets" are.
*
Exacerbate this drain on the real economy and consumer (you) by then loaning that money back to you at interest.

I see only damage there to the real economy and to taxpayers, not benefit.

This mistake is the root of all of the so-called "liquidity facilities" proposed thus far, and it is precisely the same set of mistakes made during 1929-31 that led to what was destined to be an ordinary (if deep) recession turning into The Great Depression.

Nor does it stop there. Obama declared that his first priority was a "second stimulus."

The problem with such a "stimulus" is that it can't and won't work, and public support for same relies on the ignorance of the body politic. As I demonstrated the last time the first "stimulus" cost you more in the first year if you were a home buyer than you got in the check; that is, it had a negative real value to you, and worse, it continued to accrue that negative value through the next 30 years!

This is what must happen because our government does not have a surplus from previous "good years" banked in the Treasury; if we had we could use it to cushion the blow. But since our government has never managed to accumulate such a surplus any such "stimulus" is in fact coming out of your pocket in the form of additional debt upon yourself in order to pay yourself.

It is exactly identical to you having $20,000 worth of credit card debt, "rolling it over" into a new credit card and then charging up the now-cleared credit line. You have not improved your financial situation one iota but rather have made things much worse!

Yet this is what President-Elect Obama and the Democratic party have proposed.

We're headed for another Depression folks and I no longer consider the actions that are being taken by our government to be "mistakes" - at this point they must be classified as knowing and intentional acts, depending on you, the public, being too ignorant of how banking and finance work to figure it out and demand that they stop it.

"Stop it" means what I've said all along - force the bad debt out into the open where it must be recognized and defaulted, no matter who it screws, then pick up the necessary pieces. This will result in a lot of bankruptcies but it will also realign debt payment capacity with debt outstanding, which is the critical element that must and will come back into balance.

We can do this via the marketplace or we can continue to increase the imbalances and guarantee a far worse outcome; it is only through government endorsement of a refusal to recognize insolvency that recessions are turned into Depressions, and right now we're getting it in spades.

If you're wondering how bad it can get, and how fast, read this:

"Overnight, people lost their savings. Prices are soaring. Once-crowded restaurants are almost empty. Banks are rationing foreign currency, and companies are finding it dauntingly difficult to do business abroad. Inflation is at 16 percent and rising. People have stopped traveling overseas. The local currency, the krona, was 65 to the dollar a year ago; now it is 130. Companies are slashing salaries, reducing workers’ hours and, in some instances, embarking on mass layoffs.

“No country has ever crashed as quickly and as badly in peacetime,” said Jon Danielsson, an economist with the London School of Economics. "

To "borrow" (sorry, no interest either Barack) a couple of our new President's slogans:

Yes we can - have a Depression.

Yes we will - have a Depression, unless our "leaders" stop it, and President Obama and The Democrats will own it, being the party with complete control of Congress and the White House.

Our government is counting on you remaining ignorant.

Will you meet their expectations?

PS: Watch Ireland. Closely.

http://market-ticker.org/archives/651-He...ssion.html