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The slide into the financial abyss...

Riding into Recession,Falling off Cliffs and Worse - February 19, 2008

The few who understand the system, will either be so interested in its profits, or so dependent on its favors that there will be no opposition from that class. The great body of people, mentally incapable of comprehending the tremendous advantages will bear its burden without complaint.

And it’s true; the vast majority of us are hoping we will somehow manage to muddle our way through this crisis. What we are secretly hoping for is a continuation of the good life no matter what price is being paid. Even if it means the destruction of our environment and that the rule of the land is fraud and graft, we simply are willing to surrender ourselves to criminals as long as we can go on. Let’s be honest, we are all attached to the system like a wife or lover and will suffer tremendously from its loss.

1.6 million borrowers defaulted on their home loans last year and millions more are anticipated in the next few years.
New York Times

Jan Hatzius, chief United States economist at Goldman Sachs, wrote in a research note on the 11th of February that he was convinced the economy was already in a recession and he warned that losses in the housing market could be even bigger than the $400 billion that Goldman predicted several months ago. And as the media fixates on the housing losses the fox is stealing the hens in other huge areas like credit card delinquencies. What we are living through is just the beginning of a downpour.

We were giving out loans to anyone with a pulse.
Johnny Placeres
Loan officer at MidAmerica Bank

Each raindrop is one loss being reported and of course we only hear about a few raindrops a day. But it’s pouring and the storm drains are threatening already to spillover into our lives. Just over a week ago Greenspan said the economy will continue to erode until there is a stabilization of U.S. housing prices and that at the moment we are on the “edge.” Translated this means that we are in freefall and will continue to drop down in economic activity for a long time to come for no bottom is in sight for housing. The numbers are grim and will get grimmer unless alien invaders save us by remonetarizing all of our debt and wealth – which in today’s economy is one and the same thing.

The New York Federal Reserve's Empire State Manufacturing Survey indicated on Friday the 15th that conditions have deteriorated this month. The reading fell nearly 21 points to negative 11.7 — the first negative reading since May 2005. Analysts had forecast a decline of only 6.5 percent, according to Dow Jones Newswires, showing that things are dropping off more quickly then anyone is admitting.

“We’re sliding into recession, or worse,” writes Robert B. Reich, a professor of public policy at the University of California, Berkeley. He continues saying, “and Washington is turning to the normal remedies for economic downturns. But the normal remedies are not likely to work this time, because this isn’t a normal downturn. The problem lies deeper. It is the culmination of three decades during which American consumers have spent beyond their means. That era is now coming to an end. Consumers have run out of ways to keep the spending binge going.” The rapid disintegration of our economic system and the 'worst is yet to come' is the order of the day as fear grips investors worldwide.

The crisis that began with subprime mortgages is spreading like a plague through the credit markets as one part of the debt market after another buckles. High-risk loans used to finance corporate buyouts are plummeting in value and even securities backed by commercial real estate mortgages have fallen sharply. And as we shall see below, auction-rate securities, usually considered as safe as cash, are in free fall. What we are seeing daily in the news is lenders recognizing the value of their loans declining forcing them to report as a loss the difference in the value at which they made loans and the prices of similar debt in the secondary, or resale, market.

Credit Suisse said today it was writing down a further 2.85
billion dollars worth of assets. Credit Suisse shares plunged in opening trade on the Zurich stock exchange, down 6.7 percent. The new writedown comes less than a week after Credit Suisse said it had broadly contained subprime losses in 2007.

The breadth and scale of the declines mean more pain for major banks, which will make them even more reluctant to make the loans needed to grease the falling American economy. The losses keep piling up with each loss contributing to other peoples’ and institutions losses. The entire debt and securities market is in the process of seizing up meaning its going to be a lot worse then Humpty Dumpy falling off a big wall. To stem the fall banks in the United States have been quietly borrowing "massive amounts" from the U.S. Federal Reserve in recent weeks, using the Fed's Term Auction Facility (TAF), which allows banks to borrow against a wide range of their assets. We have seen them borrow nearly $50 billion of one-month funds from the Fed by mid-February and this is beginning to create alarm because it mirrors the losses developing in opaque corners of the U.S. banking system. It also shows the banking systems growing reliance on indirect forms of government support.

Financial history is rife with examples of market breakdowns that followed the creation of complex securities.

“Troubles that began a little over a year ago in an obscure corner of the financial system, BBB-minus subprime-mortgage-backed securities, have spread to corporate bonds, auto loans, credit cards and now — the latest casualty — student loans,” wrote Paul Krugman for the New York Times. This week the state of Michigan suspended a major student-loan program because of the sudden collapse of another $300 billion market we’ve never heard of, the market for auction-rate securities.

One has to read Kugman’s article for we have another financial disaster in the making. The Port Authority just saw the interest rate it pays leap from 4.3 percent to 20 percent because of these securities and the investors who own these securities are losing their shirts because no one wants to buy auction-rate securities anymore; the auctions are failing. Krugaman said of this, “Frustrated investors who can’t get their money out of auction-rate securities aren’t as photogenic as angry mobs milling outside closed banks, but the principle is the same.”

You ever hear of auction rate securities before? What’s it going to be next week? The answer is companies that insure bonds. At issue is whether the guarantors have enough capital to pay out the expected future losses on the bonds they have guaranteed. Until recently many analysts thought they did, but as defaults on mortgages have surged, many, including the ratings firms, have begun to question their previous assumptions.

If the insurers lose their ratings, it would strip the implied triple-A rating from thousands of municipal bonds that carry protection from the firms, increasing the borrowing costs of cities, states and other issuers. Wall Street banks would also be forced to write down the value of mortgage securities they had protected through the guarantors. Again we are talking about huge amounts of money, much higher interest rates to municipalities and potentially huge losses to banks whose capital base continues to shrink.

Credit default swaps and many other sophisticated financial instruments that form a large part of international wealth will be put to a big test as a looming economic downturn strains companies’ finances. Like a homeowner’s policy that insures against a flood or fire, these instruments are intended to cover losses to banks and bondholders when companies fail to pay their debts. The market for these securities is enormous. Since 2000, it has ballooned from $900 billion to more than $45.5 trillion — roughly twice the size of the entire United States stock market.

Credit default swaps have proliferated so rapidly, experts say that a hiccup in this market could set off a chain reaction of losses at financial institutions, making it even harder for borrowers to get loans that grease economic activity. Last week, the American International Group said that it had incorrectly valued some of the swaps it had written and that sharp declines in some of these instruments had translated to $3.6 billion more in losses than the company had previously estimated.

A crisis is looming in which students and families may not have access to student loans.
Ben Kiser

Talking about a chain reaction that is what this is all about; what we have is a cascade of losses feeding each other contracting the very fabric of modern civilization. Now we are even getting warnings about educational finance with some in the lending industry warning that there may be fewer borrowing options, even for traditional students, in the fall, at least for private loans, which students turn to when they have exhausted federal borrowing and grant aid. Banks, fearful of bad credit, are not cutting rates and have said they may not lend at all to students seen as high risks. This will make many colleges and students vulnerable.

We have to remember what making a loan is supposed to be all about. It’s with the expectation that the loan will be paid back with interest. One of the reason’s we are in this financial hell storm, which is just beginning to gather in force, is that this holy banking principle was trashed and money was loaned without regard to payback potential.

With the creation of debt we can enjoy prosperity at the expense of our own future.

When large amounts of money are borrowed and utilized within society, an illusion of prosperity appears.

Now banks have swung like a weighted pendulum all the way over to the side of extreme caution. Lending is collapsing as the human economic universe is looking increasingly like a bad bet. Risk taking has its limits and that limit has been passed in the last six months with things getting worse by the month. In a darkening financial world lending becomes equivalent to monetary suicide for banks - though there are huge pockets of money out there, in certain investors’ hands, which will get thrown into the system when it’s for sale at fireside prices. Banks are desperately going after these kinds of investors from the Middle East and elsewhere to stick their thumbs in the dike of losses. They will pay through the nose for foreign capital infusions and surrender a lot of control.

The fourth quarter was terrible, but you had strong investment banking revenues. Now you’ve had a bad December, a worse January and an even worse February.
Brad Hintz
Sanford C. Bernstein & Company

In the land of economics we find out that debt and money are “fungible”. That simply means they are interchangeable and for all intents and purposes the same. Debt is money and money is debt. The sudden rapid destruction of debt (every write down you hear coming out of the financial sector) has the effect of destroying money. If debt is destroyed fast enough you get a rather sudden contraction in money supply. This is known as deflation.

Debt is the greatest of all dangers to be feared.
Thomas Jefferson –1816

“The American Empire is a bit like General Motors. It has heavy fixed costs, an aging workforce, worn-out equipment, mammoth debts, and it is losing market share. At immense cost, America maintains its legions in more than 100 overseas garrisons,” writes Bill Bonner in the Daily Reckoning. America has been able to wall paper all of its problems with mind boggling debt creation only because the dollar has been the international reserve currency. This party is ending; it’s very late in the borrow your way scam.
Americans were only able to increase their standards of living by putting their wives to work, putting in more hours on the job, and finally, going deeply into debt.

“The obvious conclusion,” writes Paul Rye, “is that debts cannot be repaid. They cannot even be significantly repaid, or the contraction in the money supply will lead to a vicious circle and deflationary depression. This applies to Government national debt and personal debt alike. The "fleas" on the dog must be tolerated. But, debt cannot be rolled over forever either, because gradually increasing debt/income ratios will eventually also overtakes the ability of borrowers to make payments.”[ii]

We are now seeing credit destruction and bank impairments happening faster than Fed and Congress are acting. Capital is now being destroyed at a faster pace than it is being created. A deepening recession, a falling stock market, plunging commercial real estate, and social acceptance of walking away from mortgages and credit card debt are all going to make Bernanke’s job impossible. The Fed is already bailing out the banks providing them at low interest huge loans so they do not run completely out of cash capital to lend.

The correction of debt backed wealth is going to be a lot deeper and wider and more prolonged than anyone is predicting so far. Never has a civilization reached so high in human history. America has been sitting on top of an ever expanding base of wealth that reaches around the world. Her fall from the heights will be dramatic even cataclysmic. Sadly, because of the distance between the heights and the pit that lies at the bottom, there will be plenty of time for financial screams, daily reports of billions more lost to someone. Perhaps we should celebrate the demise of the wealthier factions of humanity but somehow we know that no one is dancing.

In financial terms we have the makings for economic Armageddon simply because people and banks don’t know what the value is of their assets anymore. Investors haven’t been able to sort out what’s good and what’s bad, so they are beginning to throw all credit assets out. What do you think is going to happen when the day comes that they start throwing out on the value of the dollar? Isn’t that a disaster that is just waiting to happen?


( 4 comments — Leave a comment )
Feb. 20th, 2008 03:45 pm (UTC)
Into The Abyss
From Wolf Laurel in NC mountains - We haven't seen the beginning of the worst yet for the recession/depression sweeping the US. I believe Merrill Lynch is correct about the arrival of recession in the United States. The housing downturn is negatively impacting property sales in second home communities in Florida. This is also slowing sales in NC mountain resorts that depend on Florida buyers.

Still the downturn in prices and building of inventories is starting to attract second home buyers from Florida looking for cool temperatures in our mountains. Also the dramatic decline in the dollar combined with weakness in American real estate markets are beginning to interest some bargain hunting European investors.

Ron Holland, Broker/Realtor with Wolf's Crossing Realty. See www.ronaldholland.com Ron markets resale mountain and ski resort properties in Wolf Laurel and The Preserve at Wolf Laurel.
Feb. 20th, 2008 07:58 pm (UTC)
Oh did it gone?
Oh are it left?
I all broke
This cannot was!
Feb. 20th, 2008 11:24 pm (UTC)
i can...
i can hasz a cheezeburger...

Feb. 26th, 2008 09:37 pm (UTC)
Re: i can...
just 1.99 terabucks with a soda and a shake. If you're paying in million-dollar bills better bring a wheelbarrow.
( 4 comments — Leave a comment )