The Great Credit Unwind Of 2008

In Monday's Financial Times, Harvard economics professor, Lawrence Summers, made an impassioned plea for further government action in addition to the Fed's rate cuts and Bush's $150 billion "stimulus plan". Summers believes that steps must be taken immediately to mitigate the damage from the sharp downturn in housing and persistent troubles in the credit markets. He suggests a "global coordination of policy", which is another way of admitting that the Fed has lost control of the system and cannot solve the problem by itself. Summers is right, although it's easy to wonder why he remained silent while the markets were soaring and the investment banks were reaping trillions of dollars in profits on a "structured investment" swindle which has left the global financial system teetering on the brink of catastrophe. Now that the US economy is sliding towards recession; Summers is calling for "transparency". How convenient. "Financial institutions are holding all sorts of credit instruments that are impaired but are difficult to value, creating uncertainty and freezing new lending. Without more visibility, the economy and financial system risk freezing up as Japan's did in the 1990s." Right again. The banks are "capital impaired" because they are holding nearly $600 billion in mortgage-backed assets which are declining in value every month. This is forcing many banks to conceal their real condition from investors while they scour the planet for the extra capital they need to continue operations. As long as the banks are in distress, consumer and business lending will dwindle and the economy will continue to shrink. The main gear in the credit-generating mechanism is now broken. The rate cuts can provide liquidity, but they cannot bring insolvent banks back from the dead. Summers is expecting too much. The US' current account deficit (nearly $800 billion) has been recycling into US Treasuries and securities from foreign investors. Up to this point, American markets were an attractive place to put one's savings. The dollar was strong, and the stock market had a proven record of profitability and transparency. But since President Bill Clinton repealed Glass-Steagall in 1999, the markets have been reconfigured according to an entirely new model, "structured finance". Glass-Steagall was the last of the Depression-era bulwarks against the merging of commercial and investment banks. As a result banking has changed from a culture of "protection" (of deposits) to "risk taking", which is the securities business. Through "financial innovation" the investment banks created myriad structured debt instruments which they sold through their Enron-like "off balance" sheets operations (SIVs and Conduits) Now, trillions of dollars of these subprime and mortgage-backed bonds---many of which were rated triple A---are held by foreign banks, retirement funds, insurance companies, and hedge funds. They are steadily losing value with every rating's downgrade. Summers, of course, understands the enormity of the swindle that has taken place beneath the noses of US regulators, but chooses not to point fingers. Instead, he draws our attention to a little known part of the market which will probably lead the way to a stock market crash and a system-wide meltdown. ... http://www.counterpunch.org/whitney01292008.html

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