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Bernanke Deep-Sixes the Dollar to Save Wall Street
Contre Info
Sunday 16 March 2008
In the absence of the authority and political courage required
to cut to the quick, the Fed has been reduced to using expedients that - while
allowing the extent of losses to remain concealed - postpone the moment of truth
and compromise the dollar. To save Wall Street, Bernanke exports the crisis
and stokes a global inflationary fever, risking a devastating boomerang: rejection
of the dollar as the global reserve currency.
Basic Math
Mortgage-backed securities in circulation total $11,000 billion. US real estate
is overvalued by 20 to 30 percent. If a quarter of the wealth of US households
vaporizes, that represents $2,750 billion worth of debt that will probably not
be repaid and will become losses for the financial system.
According to the study by Greenlaw, Hatzius, Kashyap and Shin (pdf), the
total capitalization of United States' banks, government agencies and savings
banks amounts to $1,681 billion.
Their direct exposure to mortgage securities totals $5,591 billion, or half
of the outstanding amount. They are, consequently, potentially faced with write-downs
of up to $1,375 billion - close to their total capital.
These figures do not take into account possible losses in other credit sectors:
consumption, auto loans and commercial real estate.
Credit-related risks are covered by insurance contracts signed by mutual agreement
between companies - CDS or Credit Default Swaps - bearing a total value of $45,000
billion, over three times the United States' gross domestic product.
If this risk coverage mechanism is set in motion, it could propagate a cascade
of refund demands from "counterparties" - that is, those that sold
the insurance - counterparties which for the most part have no provisions available
to meet those calls.
Speculative funds - hedge funds - are also involved. These enterprises are
based on the principle of massive credit use - called leveraging - to increase
their earnings. Here's how:
Mr. Smith has $100 to invest and buys a mortgage-backed security that earns
$8 a year. By borrowing $1,500 at 6 percent to invest 15 times more, he earns
a total of $128, pays $90 in interest and is left with a net return of $38 for
an initial outlay of $100.
An excellent return until the day the securities lose 20 percent of their value.
The lending bank demands reimbursement. Mr. Smith sells his securities: $1,600
less (20 percent) $320 = $1,280. He has lost his $100 and owes the bank $220.
It is, in fact, this mechanism of inverse leveraging that is asphyxiating "the
auxiliary banking system," i.e. the investment funds.
Illiquidity and Insolvency
The central banks, lenders of last resort, can help healthy establishments
meet a strained liquidity situation by supplying an interim loan. But the situation
in which the financial system finds itself does not result from a lack of liquidity.
It's an insolvency - that is, bankruptcy - crisis.
The market will only recover stability and confidence on three conditions:
That the insolvent enterprises disappear and the bad paper they are holding
along with them; that the companies that can survive receive a capital infusion
to offset their losses; and that falling real estate assessments reach true
prices, at the same time restoring a reliable value to the securities backed
by those assets.
That's a great deal of ground to cover. Especially when the tool for intervention
- the central bank - is absolutely not adapted to the mission of the day: saving
Wall Street.
Bernanke's Tool Box
Bernanke has two levers he may use: loans and rates.
He uses these two tools on either end of the financial institution balance
sheet: the reserves in the banks' portfolio and real estate values. Loans reinforce
banks' capital funds; the reduction in rates, which would normally re-launch
economic activity, should also shore up real estate prices by bringing the recession
to an end.
But these two axes of intervention have their limits - and their perverse consequences.
As the crisis has intensified, the loans have lost their character as a very
temporary interim measure against illiquidity to take on the aspect of concealed
infusions of capital. The requirement for impeccable collateral, securities
held at the central bank as a guarantee for the liquidities accorded, has been
relaxed in the extreme. Instead of Treasury bills, the Fed is now accepting
dubious real estate debt for which there is no longer any market. The term of
these loans, normally overnight, has now been extended to three months. The
volume of these operations has become significant: $400 billion or half the
Fed's available reserves are committed to the end of March.
This massive and very unconventional intervention presents two major disadvantages.
While it authorizes banks to maintain presentable balance sheets, by deferring
the moment when the accounts will be sold off in pain, it does allow time to
be gained, but does not reestablish confidence - which will be restored only
when the losses have been recognized. On the other hand, by virtue of its very
scope, the intervention indicates that the Fed is losing ground. At the rate
things are going, the Fed's $400 billion war chest in the form of Treasury Bonds
on its books is no longer an indication of its strength, but of its weakness.*
To what expedients will it be reduced when it comes to the end of its reserves?
The printing press? We can see on the horizon that the very credibility of the
dollar is at stake.
The Dollar, Collateral Victim
The massive and repeated rate reductions Bernanke has chosen - we expect another
one tomorrow - directly challenge the status of the American currency.
As his predecessor did at every slowdown of activity, the new Fed chairman
tries to relaunch the credit machine, hence monetary creation, to prop up the
economy and prices and to break the deflationary spiral.
Without much success. The gears in the transmission have jammed and the confidence
of already-overextended households and companies is faltering.
But as he acts this way, he reinforces the already well-anchored sentiment
that the dollar - weighted down by the United States' $9,000 billion debt that
cannot be reimbursed - is overvalued, which amplifies the American currency's
slide.
The inflows of foreign capital that have allowed deficits to grow and the currency
to maintain its value for twenty years (the Clinton episode aside) are in the
process of drying up. During the last three months of 2007, the influx of foreign
investments went from $113 billion to $56 billion.
Just recently, US Treasury bonds have been evaluated as less reliable than
Germany's.
This drop in the dollar Bernanke has accepted and precipitated to save Wall
Street looks like a runaway train that will export the American crisis to the
rest of the world, and do so at an exorbitant cost.
Since most raw materials markets, including most obviously oil, are denominated
in dollars, the slide in the US currency mechanically entails a revaluation
of raw materials' prices and provokes significant global inflation.
This phenomenon is further reinforced by the flight of capital abandoning dollar-denominated
securities, the value of which is melting like snow in the sun, and seeking
refuge in raw materials markets.
Indecision 2008
Because it cannot "think the unthinkable," that is, accept the extent
of the losses and take the drastic measures that are required: true prices,
nationalizations and bankruptcies, the United States, by deferring the purge,
allows the toxic contagion imprudently concocted on Wall Street to propagate.
The United States' trompe l'oeil economic success, built on the engine of debt,
asset inflation and the influx of capital its currency's status allowed, threatens
to collapse.
The man occupying the Oval Office is obviously not equal to the situation,
and the next team will not be in command before next January.
From now until then, Bernanke does what he can, with the tools that he's got.
Thus, the United States takes the road Japan took in 1991, but without the same
advantages. It has no savings and its industrial base has been massively eliminated.
There remains the dollar, the symbol of the preeminence of empire. But by exporting
its crisis, the US plays double or nothing. Either the pain provoked by the
greenback's fall forces the global powers to take concrete action or we run
the risk of witnessing the overthrow of the global economic and financial system
with the disorderly desertion of this fallen idol.
*The announcement of support for the purchase of Bear Sterns has just mobilized
an additional $30 billion, reducing this sum by an equal amount.
Translation: Truthout French language editor Leslie Thatcher.
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