Posted on 03/03/2008 4:54:16 AM PST by TigerLikesRooster
The Federal Reserve's rescue has failed
By Ambrose Evans-Pritchard, International Business Editor
Last Updated: 11:10am GMT 03/03/2008
Have your say Read comments
The verdict is in. The Fed's emergency rate cuts in January have failed to halt the downward spiral towards a full-blown debt deflation. Much more drastic action will be needed.
Read more from Ambrose Evans-Pritchard 'Ninja' loans explode on sub-prime frontline Yields on two-year US Treasuries plummeted to 1.63pc on Friday in a flight to safety, foretelling financial winter.
advertisement
The debt markets are freezing ever deeper, a full eight months into the crunch. Contagion is spreading into the safest pockets of the US credit universe.
It is hard to imagine a more plain-vanilla outfit than the Port Authority of New York and New Jersey, which manages bridges, bus terminals, and airports.
The authority is a public body, backed by the two states. Yet it had to pay 20pc rates in February after the near closure of the $330bn (£166m) "term-auction" market. It had originally expected to pay 4.3pc, but that was aeons ago in financial time.
"I never thought I would see anything like this in my life," said James Steele, an HSBC economist in New York.
No sane mortal needs to know what term-auction means, except that it too became a tool of the US credit alchemists. Banks briefly used the market as laboratory for conjuring long-term loans at Alan Greenspan's giveaway short-term rates. It has come unstuck. Next in line is the $45trillion derivatives market for credit default swaps (CDS).
Last week, the spreads on high-yield US bonds vaulted to 718 basis points. The iTraxx Crossover index measuring corporate default risk in Europe smashed the 600 barrier. We are now far beyond the August spike.
Sub-prime debt is plumbing new depths. A-rated securities issued in early 2007 fell to a record 12.72pc of face value on Friday. The BBB tier fetched 10.42pc. The "toxic" tranches are worthless.
Why won't it end? Because US house prices are in free fall. The Case-Shiller index for the 20 biggest cities dropped 9.1pc year-on-year in December. The annualised rate of fall was 18pc in the fourth quarter, and gathering speed.
As the graph shows below, US households are only halfway through the tsunami of rate resets - 300 basis points upwards - on teaser loans.
The UK hedge fund Peleton Partners misjudged this fresh leg of the crunch. After an 87pc profit last year betting against sub-prime, it switched sides to play the rebound. Last week it had to liquidate a $2bn fund.
Like many, Peleton thought Fed rate cuts from 5.25pc to 3pc (with more to come) would end the panic. But this is not a normal downturn, subject to normal recovery. Leverage is too extreme. Bank capital is too eroded. Monetary traction eludes the Fed. An "Austrian" purge is under way.
Credit Suisse says the cost of the credit debacle will reach $600bn. "Leveraged risk is a cancer in this market."
Try $1trillion, says New York professor Nouriel Roubin. Contagion is moving up the ladder to prime mortgages, commercial property, home equity loans, car loans, credit cards and student loans. We have not even begun Wave Two: the British, Club Med, East European, and Antipodean house busts.
As the once unthinkable unfolds, the leaders of global finance dither. The Europeans are frozen in the headlights: trembling before a false inflation; cowed by an atavistic Bundesbank; waiting passively for the Atlantic storm to hit.
Half the eurozone is grinding to a halt. Italy is slipping into recession. Property prices are flat or falling in Ireland, Spain, France, southern Italy and now Germany. French consumer moral is the lowest in 20 years.
The euro fetches $1.52 (from $0.82 in 2000), beyond the pain threshold for aircraft, cars, luxury goods and textiles. The manufacturing base of southern Europe is largely below water. As Le Figaro wrote last week, the survival of monetary union is in doubt. Yet still, the ECB waits; still the German-bloc governors breathe fire about inflation.
The Fed is now singing from a different hymn book, warning of the "possibility of some very unfavourable outcomes". Inflation is not one of them.
"There probably will be some bank failures," said Ben Bernanke. He knows perfectly well that the US price spike is a bogus scare, the tail-end of a food and fuel shock.
"I expect inflation to come down. I don't think we're anywhere near the situation in the 1970s," he told Congress.
Indeed not. Real wages are being squeezed. Oil and "Ags" are acting as a tax. December unemployment jumped at the fastest rate in a quarter century.
The greater risk is slump, says MIT Professor Paul Krugman. "The Fed is studying the Japanese experience with zero rates very closely. The problem is that if they want to cut rates as aggressively as they did in the early 1990s and 2001, they have to go below zero."
This means "quantitative easing" as it was called in Japan. As Ben Bernanke spelled out in November 2002, the Fed can inject money by purchasing great chunks of the bond market.
Section 13 of the Federal Reserve Act allows the bank - in "exigent circumstances" - to lend money to anybody, and take upon itself the credit risk. It has not done so since the 1930s.
Ultimately the big guns have the means to stop descent into an economic Ice Age. But will they act in time?
"We are becoming increasingly concerned that the authorities in the world do not get it," said Bernard Connolly, global strategist at Banque AIG.
"The extent of de-leveraging involves a wholesale destruction of credit. The risk is that the 'shadow banking system' completely collapses," he said.
For the first time since this Greek tragedy began, I am now really frightened.
Ping!
Time for Benny Boy to gas up the choppers!
What’s the best way to capture money falling from the sky? Some kind of vacuum apparatus?
Misdiagnose the problem, then apply exactly the wrong solution....
SOP for gummint.....
He’s a nutjob anyway. He has a conspiracy theory for everything in the news.
No more “room” to borrow. The market for borrowing is tapped out.
This phrase aptly captures the gravity of the current event.
The question that Mises posed is will the Fed go quietly into the recession or will they destroy the currency instead?
There’s always a market for free money.
Authors are eu-biased and do not mention that the euro is about to start an easing cycle that will level the monetary field.
Deflation, huh? I think not. The Fed may well drop the lending rate to zero. But the banks will become so risk averse that they will not lend, except at sky high interest rates. So, this will give them a huge profit on $$ they do lend (allowing them to recharge their batteries). As a result, prices for everything will go higher. That is what typically happens when you start printing $$ like there’s no tomorrow and raising interest rates. This will worsen the situation as people will have to pay higher prices on one hand, higher interest rates on the other, and have no more room to borrow. Buckle your seat belts!
re: Austrian purge - I don’t know where you stand on this, but it sure seems to me that government tinkering causes the problem, not solves the problem. You think the fed is trying to divest itself of those that think likewise?
Watch out below! Big day today...
If I email him my address, do you suppose he’d start at my place?
Heck, I’ll make an extra pot of coffee for the guys and might hire a couple dancing girls or somethin!!
I hope he rewrites his article again, after calming down. He seems really rattled by the ongoing development.
BINGO!!!
You don’t understand the situation with the shadow banking “system” if you believe deflation is not underway. As debt comes back on the books of the lending institutions, massive reserves are being eaten up in the writedowns accompanying this event. Credit is scarce, and the money supply is shrinking.
Look up the meaning of deflation and inflation and you’ll see what I mean, esp. the Austrian definitions.
To put it in extremely simplistic terms, in a fractional reserve system, money supply is created by debt/lending. Ergo, if debt is being written off (destroyed) then the money supply is collapsing. Add to that the fact that many people are already past their max debt load, those who are not will have a harder time qualifying for credit, and you have a massive slowdown in the credit markets, keeping the money supply from increasing.
The Treasury can print all they want, but they can only do it by devaluing the dollar, so interest rates will then climb to the moon and lending will freeze further. Anybody who lived thru 20% interest rates in the 80s has seen this first hand.
Inflation is not individual prices, but is a function of the money supply relative to productivity, ie a general price level. Individual prices, like oil and wheat, may increase, but they are simply sucking money from other things like housing, minis and commercial lending to name just a few.
In short, deflation is real and the so-called inflation is just a lagging indicator.
Politicians have no choice but to destroy. It’s a self-interest phenomenon for re-election, giving away money to buy votes.
If they vote for deflation, they do not win reelection.
According to the old song, make sure your umbrella is upside down!....................
There’s not going to be a housing rebound (as that term is currently defined) anytime in the near future. In fact, there may never be such a rebound.
The housing market may indeed have been permanently changed by this bust. By that I mean, the fundamental mentality underlying the housing market at the consumer level.
In the housing market, it’s always been this way: only a tiny minority of housesales were driven by sellers who “must” sell. IOW, who put their houses on the market because they “had to” try to sell for some financial or personal reason.
And no one ever “had to” buy, as rentals are always available.
That meant that the vast majority of every housing market was made up of those who simply “wanted to”-—wanted to buy their first home, wanted a bigger house, wanted to (but didn’t have to) move to a new location, wanted a better yard, wanted a sunroom/granite countertops/a jacuzzi/two garages, etc. etc. etc.
Or who wanted to invest in real estate to make money off those who simply “wanted to” buy/move.
If, for a whole bunch of reasons, that fundamental mentality changes and people no longer cotton to the former motivations that led to (literally) movement in the housing market, the market will not ever return to its former state.
Sort of like when people started hanging on to their cars longer-—and then MUCH longer-—instead of trading them in every few years.
The McMansion flood put many people in homes they will never outgrow size-wise or, really, amenity-wise. But even apart from that, there’s a complete shift away from even thinking about “moving up,” and so on.
I wouldn’t be surprised to see a sustained return to the mentality that you buy the family home and pretty much stay there unless you’re “forced” to move.
Good idea. Dancing girls definately gets you bumped up on the drop list.
Tell the ladies to watch out for the rope ladder. :-)
and that is the reason for getting a little worked up about this.
All the measures of the economy (economic growth) are based, ultimately, on the number of dollars that moved. Not the number of cans of beans that got sold, or whatever.
So if lending slows down significantly, those numbers are doomed to fall. And there is a HUGE pyramid of financial “assets” (hedge funds, etc) that are built into the system and NEED, DESPERATELY NEED that number to keep going up.
I did not know that cuts were suppose to work by the next month or be deemed a failure. Besides there are probably even another 1.5 points worth of cuts left. So perhaps it is a bit premature to say what the cuts have and have not done.
A Federal Reserve rescue can only fail. It is government intervention which, at its best, delays a recovery and at its worst, converts a sluggish economy or mild recession into a full-bore depression.Politicians labor under the delusion that something as big and diverse as the Economy can only work if is few technicians are turning knobs and pulling levers in the Capital. They cannot imagine a society or an economy running without the Experts keeping it all on track. In the meantime they are trying to drive the train sideways on the track and are shoveling coal into the diesel tank.
The “family home” idea only worked when employment was stable. In our more dynamic economy, with companies constantly shuffling jobs, buying is probably a bad idea because it means every few/five years you need to sell with all those attendant costs.
Exactly. I think we are only seeing the start of the deflationary spiral. Foreclosures lag by about 6 months - with the huge number of resets that will occur this month, August/September should see an absolutely huge spike in foreclosures and defaults.
It is then, I think, if not before, that we’ll start to see bank failures that can no longer be contained by the Fed.
Cut our corporate tax rates to zero, encourage companies to come back to America. Cut capital gain taxes further, stop taxing savings and start taxing consumption rather than income.
Fix our damned immigration division so we can quickly and confidently encourage immigration of the best and brightest.
We can grow out of the slump if our government would get the hell out of the way.
This would also go a long way toward fixing the SS short-fall that will be impacting us in the future. It’s hard to have a growing economy with a static population.
Until the next bubble. The next real estate bubble will be cooked up by the boomers when the herd decides to all move somewhere. People in Phoenix though that would happen this bubble. My guess is it will be some cheap dumpy place in the South next time.
Ben, you’re gonna need a bigger chopper.
Silver up 60 cents, expect another dollar day.
Gold is gonna face alot of tough resistance at 1000 but if that breaks, 1300-1700 will be no problem at all.
Lots of fiat looking for safe havens. Literally tons and tons and tons.
And that is one of the Fed's biggest problems. See graph in post 4.
Thanks very much. That’s one of the hazards of posting with a text-only browser. I see looking at the source that I must have pressed paste twice.
“It’s hard to have a growing economy with a static population.”
So does that mean you are an open border zealot?
Every time we fill our gas tanks we are helping support terrorism. Every time another industry moves its production to China to avoid the hassles of doing business in America we are losing the very essence of what made America the country she became over 200 years.
I can’t say anything about the article, one way or the other, but I know that speaking for me and my family we are slowly sinking into disaster. Our insurance went up 300 percent in one year, gas is costing more every day, groceries are going up every day, etc.
Does that mean you where dropped on your head when you where little and are still stupid or just a faulty short circuited clairvoyant?
Did you see the words “fix our immigration to allow the best and brightest” in my post?
5...
4...
3...
2...
1...
???????????
I don’t know the rest.:-)
Countdown to the Street opening.
Not bad. Only down 40 or so now.
Ben's got a backup plan.
“Since 1954, the Standard & Poor’s 500-stock index has surged 13 percent, on average, in the six months after the first in a series of Fed rate cuts. Well, nearly half a year has passed since the Fed began to lower short-term rates, last Sept. 18. But this time, the S.& P. 500 has lost more than 12 percent of its value.”
http://www.nytimes.com/2008/03/02/business/02fund.html?_r=1&ref=business&oref=slogin
Yep. Our credit card bill was literally three days late and they shut the cards off. I pay triple the minimums every month and pay the bills bi-weekly. The 3 day payment gap came this month because February is a longer month.
I live in Maine and also have friends in Southern NH. The consumer sentiment mood is sour beyond belief. Despite being completely fiscally responsible, we are only keeping up with our bills with the ever surging costs of food, energy and healthcare. My friends can’t pay the bills, can no longer find adequate work and their credit has been completely shut off. They now come to my house for entertainment on the weekends, because we can still afford a decent bottle to drown out the misery.
Meanwhile, the ones truly accountable for this mess at the top pulled their money out of the market in June while telling the rest of the market how strong the economy still was. None of this is a shock to me but it’s amazing how most people think Obama will be the next savior of our nation when I know he will simply raise taxes.
Cramer on the tube again screamin for more cuts.
Send the dollar farther down the tube, but what the hey! It’ll look good.
He starts out his commentary saying that gold is going “in the wrong direction”, meaning going up.
Ends his spiel saying gold and energy are in bull markets so you might as well get some while you can.
Luv that guy! He’s hilarious!
One of these days his eyes are gonna bug way out and his head will spontaneously explode!
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.