The trouble with the Fed's secret bailout

The Federal Reserve has finally came clean. It now admits it bailed out Bear Stearns -- taking on tens of billions of dollars of the bank’s bad loans -- in order to smooth Bear Stearns’ takeover by JPMorgan Chase. The secret Fed bailout came months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, even months before Lehman Brothers collapsed. The Fed also took on billions of dollars worth of AIG securities, also before the official government-sanctioned bailout.

The losses from those deals still total tens of billions, and taxpayers are ultimately on the hook. But the public never knew. There was no congressional oversight. It was all done behind closed doors. And the New York Fed -- then run by Tim Geithner -- was very much in the center of the action.

The $700 billion is a ceiling on the “bucket” that can be spent at one time. The bucket can be filled essentially to infinity. The five biggest US financial institutions hold several hundred trillion, and growing, in non-marketable credit derivatives. The equities were over-valued and insured (leveraged many times over and then insured with credit default swaps, also leveraged many times over actual bank reserves, so they were and are kept at level 3 where they are not officially on the banks books) and at note rollover times, the interest is due based on their value. THe problem is when their value can be or demanded to be established by mark-to-market processes. Because the equities, especially in real estate, are known to have dropped in value, refinancing is difficult if not impossible. Repossession will expose massive bank insolvency. All the central banks of the developed world are insolvent because of overborrowing to finance credit-derivatives.

The unwinding is going on now, and the $700 billion buckets required are many in number to deal with the derivatives as they unwind. The $700 billion buckets required amount to many, many trillions which have to be supplied. Our currency cannot stand further borrowings to pay off the unwinding derivatives. THe amount of indebtedness that is being exposed as slowly as the Fed and Treasury can allow it to be exposed is MONSTROUS. The first securitization of mortgages into credit derivatives to allow the CRA to progress, and selling them worldwide, is the major combination that Warren Buffet called the origin of the “weapons of mass destruction”. Today, Warren Buffets’ Berkshire Hathaway bonds are preferable to US bonds and Tbills. WHo was right?

JMO but I think your analysis is not quite accurate. Derivatives, or credit default swaps are essentially an insurance product. Theoretically the exposure shouldn’t be more than the combined potential losses on the underlying mortgage backed securities of which derivatives were basically another layer of insurance. The fact that each time a package of mortgage backed securities was sold and likely came with a NEW CDS doesn’t really reflect the value of the underlying security. CDS’s(derivatives) were likely issued up to several times the value of the underlying securities if you assume new “policies” were issued on each trade. When the CDS’s themeselves began to be traded it was like kissing your sister. All you had was a financial instrument backed up by absolutely nothing. Each time they were traded though, somebody made a big payday.

Shadow banking allowed an unregulated insurance industry to loot banking capital by a leveraged factor of 30-40 times. So MBS losses of 30% (so far) have blown up bank capital reserves by a factor of ten. Unsurprisingly, .gov big shots would not allow their banking buddies to go down so we own all the big banks.

Look to Japan because all of this happened to them 20 years ago and they have not yet recovered. With the caveat that the Japanese looted their own pockets, not the rest of the world's.

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