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http://www.globalresearch.ca/index.php?context=va&aid=13077

Bernanke's Financial Rescue Plan: The growing prospect of a U.S. default

.......The IMF Communique to the G 20:

“The prolonged financial crisis has battered global activity beyond what was previously anticipated. Global GDP is estimated to have fallen by an unprecedented 5% in the fourth quarter, led by the advanced economies, which contracted by 7%. GDP declined by around 6% in both the United States and Europe, while it plummeted at a post-war record of 13% in Japan. Growth also plunged across a broad swath of emerging economies … against this backdrop, global activity is expected to contract in 2009 for the first time in 60 years.”
Bernanke's monetary stimulus strategy will do little to mitigate the severity of the contraction which has already gripped every sector of the economy. Credit more than doubled in the first few years of the new millennium. In fact, that total system credit jumped from $1.75 trillion in 2000 to $4.4 trillion in 2007. At the same time, the Current Account Deficit--which averaged about $100 billion per year during the 1990s-- ballooned to a whopping $788 billion in 2006. Clearly, the Fed's flood of low interest credit coupled with unsustainable deficits put the country on course for a major catastrophe. (Greenspan still says he never saw it coming) Now that the bubble has burst, Bernanke, has gone into panic-mode, frantically firehosing the entire financial system with liquidity, but with little effect. The sheer magnitude of the deflationary tidal wave is unprecedented. Here's author and economist Henry Liu:
"Globally, the dollar-denominated financial system has seen its equity market capitalization value fall by between 40-60% by February 2009....On October 31, 2007, the total market value of publicly-traded companies around the world was $62.6 trillion. By December 31, 2008, the value had dropped nearly half to $31.7 trillion. The gap of lost wealth, $30.9 trillion, is approximately the combined annual Gross Domestic Product of the US, Western Europe, and Japan.... Family net worth hit a record high of $64.36 trillion in 2nd quarter of 2007. By 4th quarter 2008, it fell to $51.48 trillion, a loss of $12.88 trillion. To restore the wealth lost in the current financial crisis, the Treasury would have to monetize some $30 trillion of toxic assets, almost ten times what the Geithner Treasury is currently contemplating, and twice the size of current US annual GDP. Add to that about $10 trillion of value lost in the collapse of commodity prices and another $10 trillion in real property values, and we have a wealth loss of $50 trillion."(Obama’s Politics of Change and US Policy on China, asia Times, Henry Liu)
Nearly half of the world's wealth has been consumed in one gigantic capital bonfire. No amount of "quantitative easing" will undo the damage to the economy. Here's a clip from Merrill Lynch's David Rosenberg adding more perspective to Liu's comments:
"Government cannot prevent nature from taking its course. While an additional $1.15 trillion expansion of the Fed’s balance sheet is large as a stand-alone event, it really is just a drop in the bucket when one considers that there is still almost $8 trillion of combined household and business sector credit that must be unwound in order to mean-revert the private sector-to-GDP ratio (which is still close to a record-high). Once again, the government is cushioning the blow, but cannot prevent nature from taking its course.
(We) feel much more confident that corporate earnings are going to slide again this year....The economy continues to contract … job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. US exports have slumped as a number of major trading partners have also fallen into recession”. This is with the Fed funds rate effectively at zero. It’s pretty clear that the Fed does not see any flicker of light at the end of the tunnel just yet. Mr. Market may be in for yet another surprise." (Interview with David Rosenberg, Tech Ticker)
The system-wide contraction can't be stopped by supporting financial institutions that made bad bets or took on perilous amounts of debt leaving them deep in the red. Fed lending should be aimed at companies that need temporary help only, like rolling over loans or getting through a rough patch while inventories are trimmed and consumers retrench. Similarly, the stimulus (monetary or fiscal) shouldn't be used to reflate assets or to try to reverse the market correction, but to maintain aggregate demand, take up slack in the sluggish economy, create jobs, and soften the blow for the victims of Wall Street's bubblenomics. Bernanke has used monetary stimulus in precisely the way it should not be used, to keep asset prices artificially high despite the cooling off in the stock market, falling corporate profits, and the steeply rising unemployment. There should be a sharp reduction in the amount lending to financial institutions, reflecting the decline in the value of the underlying assets which are now priced at roughly 30 cents on the dollar. Bernanke's job is to wind-down these positions, not perpetuate the problem at the taxpayer's expense.
According to Bloomberg: "The Federal Reserve’s top two officials assured that they will pull back their emergency- credit programs once the crisis fades, even as they prepare to flood the system further with an excess of $1 trillion.
Chairman Ben Bernanke said yesterday in Charlotte, North Carolina that the Fed must retain the flexibility to withdraw its record cash injections to restrain prices. Vice Chairman Donald Kohn said in Wooster, Ohio, “the trick will be unwinding this balance sheet in a timely way to avoid inflation.”
This is pure fiction. Bernanke has no exit strategy because the collateral the Fed now holds on its books will never regain anything near its original value. Securitization turned 80% of shaky subprime loans into AAA assets for which the Fed is now providing full value vis a vis its low interest loans. The Fed chief has made the same bad bet that the financial institutions made, and is now adding to that mistake by buying $750 billion in junk loans from Fannie and Freddie and $300 billion in US Treasurys to push investors out of the safety of cash back into the market. It's lunacy. All of this is putting more and more pressure on the dollar which could experience severe dislocation if Bernanke does not make a reasonable attempt to do what is necessary to resolve the banks, shore up consumer spending, shut down underwater financial institutions (auction their toxic assets through a RTC government-run facility) and stop trying to reassemble a broken system.
Bernanke is in way over his head. He has no plan for expanding conventional lending or strengthening the parts of the system that still work. All his efforts have been focused on salvaging insolvent banks and restarting securitization. Securitzation--transforming pools of loans into securities---was Wall Street's Golden Goose, a privately-owned credit-generating mechanism which created windfall profits by selling radioactive waste to over-trustful investors. Securitization is the epicenter of the shadow banking system, the mostly-unregulated universe of opaque debt-instruments, off balance sheet operations, and massively over-leveraged financial institutions. Securitization broke down after subprime mortgages began defaulting in record numbers sending risk-adverse investors scuttling for the exits. To illustrate how frozen the securitzation market is at present, here's a blurp from the Wall Street Journal: "Outside the market where the Fed is a buyer for securities backed by mortgage loans that conform to Fannie and Freddie standards, there hasn't been a new deal since 2007, according to FTN Financial, a fixed-income broker dealer." (Wall Street Journal, Credit Markets Still Navigate in a Choppy Sea of Liquidity)
Repeat: "No new deals since 2007."
Again from the Wall Street Journal:
"Banks and other finance companies making loans for autos, credit cards and college tuition are having virtually no success in selling those loans to other investors, a potent sign of just how tight credit markets remain.
The market for selling such loans — by packaging, or securitizing, them into bonds — had just one $500 million deal for all of October, according to Barclays Capital. That compares with $50.7 billion worth of deals made one year earlier, according to market-research firm Dealogic.” (Bond Woes Choke off some Credit to Consumers, Wall Street Journal, Robin Sidel)
Securitzation is dead, and yet, Bernanke and Geithner want to shovel another $2 trillion into this black hole hoping to lure investors back to the market. Why? Because Wall Street financiers and bank mandarins see securitization as an efficient model that can be exported into any market around the world. The repackaging of debt into complex instruments, that can be stealthily created in off balance sheet operations requiring smaller and smaller slices of capital, is the essential flimflam product that Wall Street intends to use to dominate global financial markets. Keeping secutization alive is ultimately about power; pure, unalloyed economic power. That is why Bernanke will spare no expense trying to resuscitate this failed system.
What's so destructive about securitzation is that it allows the banks to create credit out of thin air through unregulated, clandestine operations, which eliminate transparency and makes it impossible for the Fed to control the money supply. David Roache explains how this works in an excerpt from his book "New Monetarism" which appeared in the Wall Street Journal:
"The reason for the exponential growth in credit, but not in broad money, was simply that banks didn't keep their loans on their books any more-and only loans on bank balance sheets get counted as money. Now, as soon as banks made a loan, they "securitized" it and moved it off their balance sheet.
There were two ways of doing this. One was to sell the securitized loan as a bond. The other was "synthetic" securitization: for example, using derivatives to get rid of the default risk (with credit default swaps) and lock in the interest rate due on the loan (with interest-rate swaps). Both forms of securitization meant that the lending bank was free to make new loans without using up any of its lending capacity once its existing loans had been "securitized."
So, to redefine liquidity under what I call New Monetarism, one must add, to the traditional definition of broad money, all the credit being created and moved off banks' balance sheets and onto the balance sheets of nonbank financial intermediaries. This new form of liquidity changed the very nature of the credit beast. What now determined credit growth was risk appetite: the readiness of companies and individuals to run their businesses with higher levels of debt. (Wall Street Journal)
The banks have been creating trillions of dollars of credit without maintaining adequate capital reserves to back them up. That explains why the banks were so eager to provide mortgages to millions of loan applicants who had no documentation, no income, no collateral and a bad credit history. They believed there was no risk, because they were making enormous profits without tying up any of their capital........