YESTERDAY WE LEARNED that the British government's guarantee to bail out Northern Rock's creditors is worth a staggering £100 billion. That's £5,000 [$10,000] per British household. This week the European Central Bank made $500 billion available through money market operations. And only last week $110bn of new money was created by central bank loans with artificially low rates and reduced-quality security. This is money creation on an epic scale.
I find it astounding how half a Trillion dollars could get pushed out into the markets over just two weeks, and yet get almost unnoticed by the press.
What's more, this isn't the only cheap money injections that have been happening recently. The Federal Reserve has created an auction system (as opposed to the discount window) for banks to exchange bad loans for loans from the Federal Reserve. Thus by anonymous means, they are pumping $20 Billion of cash into the system every day, on a semi-permanent basis.
These are enormous numbers, but what do they mean? Isn't this what the central banks are supposed to do?
To understand the significance of this we need to look at the credit crunch side first. Then we can better understand what the central banks are doing and what it means.
Chickens Come Home To Roost
"Why do we have to think up all of these complicated new ways of losing money when the old ones still work so well?"
- CNBC
The first thing to remember is that Wall Street brought this upon themselves. You simply can't make a viable business plan out of loaning money to people who can't pay it back.
Now that home prices are falling, people that put little or no money down on their homes owe more than their house is worth. Thus any bailout plan that the government dreams up won't work for these people because there is no incentive to keep throwing good money after bad.
"There's no housing bubble..." - Fed Chief Ben Bernanke, 10/27/2005
To make matters worse, many of these homeowners haven't come to grips with the fact that their largest investment has gone down in value. Until that happens the Real Estate Bust has not bottomed.
Last year was the first nationwide decline in housing prices since the Great Depression.
That should be a scary enough fact, until you realize that almost every industry insider is predicting next year to be worse.
Existing home sales will drop 12 percent and existing home prices will fall 4.5 percent, Washington-based Fannie Mae says. Lehman analysts estimate almost 1 million mortgage loans will default in 2008, up from about 300,000 this year.
"Our customers (businesses) are having difficulty coming up with enough cash to pay their bills on time."
- Daniel North, chief economist for Euler Hermes ACI
So what does this have to do with the credit crunch?
The days of banks holding your mortgage deed is over. Now, thanks to the miracle of securitization, the person that wrote your mortgage packaged it up with a bunch of other mortgages and sold it on Wall Street as an Asset-Backed Security (ABS).
In fact, ABS's got so popular that they became the primary vehicle for mortgages during the peak of the Real Estate Bubble.
Common sense will tell you that loans made during the peak of a mania are the ones most likely to go bad. Those mortgage loans, packaged into ABS, found homes in pension funds, insurance company portfolios, foreign banks, hedge funds, and your 401k mutual fund.
They also found a home in a previously unknown financial institution known as a Structured Investment Vehicle. These SIV's dealt heavily with short-term corporate debt, also known as commercial paper. When the level of defaults on ABS hit critical mass last August, the problem spilled over into commercial paper. Suddenly the market for commercial paper dried up and this forced SIVs to go bankrupt.
"Some managers hold the view that the short-term debt market for SIV paper has been permanently disrupted and the SIV model will not survive in its current form," Moody's senior credit officer Paul Kerlogue said on a conference call.
The collapse of the ABS market has been nothing less than breathtaking.
Total Commercial Paper sank a remarkable $54.7bn to $1.784 TN. CP is now down $439bn over the past 19 weeks. Asset-backed CP dropped $27.5bn (19-wk drop of $432bn) last week to $764bn.
"Right now, the question is how bad it's going to get."
- David Rosenberg, chief North American economist at Merrill Lynch
With home prices falling, Mr. and Mrs. Joe Sixpack can no longer borrow on the equity in their home because there is none. And because they have no savings to fall back on, they turn to the worst possible alternative - credit cards.
The value of credit card accounts at least 30 days late jumped 26 percent to $17.3 billion in October from a year earlier at 17 large credit card trusts examined by the AP.[...]
At the same time, defaults — when lenders essentially give up hope of ever being repaid and write off the debt — rose 18 percent to almost $961 million in October, according to filings made by the trusts with the Securities and Exchange Commission.
Serious delinquencies also are up sharply: Some of the nation’s biggest lenders — including Advanta, GE Money Bank and HSBC — reported increases of 50 percent or more in the value of accounts that were at least 90 days delinquent when compared with the same period a year ago.
So when you add all this up you get homeowners in dire financial straights. They have to cut back. They no longer have a choice.
"We are getting close to stall speed."
- Alan Greenspan when asked about the slowing economy
And while the worst is still ahead of us, it is starting to show up in falling Christmas sales.
Dec. 24 (Bloomberg) -- Sales at U.S. stores fell for the fourth straight week as rising fuel and food prices threatened to hand retailers their worst holiday shopping season in five years.
Now while financial distress on working people doesn't even register on Wall Street's, or Washington's radar, weak sales by retailers does. This hurts profits, and that is not allowed.
So Wall Street and Washington are going to react.
But what about this "rising fuel and food prices"? Rising prices and Wall Street's reaction are directly related. Which brings us to the second part of this diary.
Bernanke's Printing Press
"Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."
- Federal Reserve member Ben Bernanke, November 21, 2002
This quote is proof that Ben Bernanke understands what price inflation really is - the falling value of a currency. It's also proof that he understands how the Federal Reserve can cause this to happen.
What it doesn't show is whether Bernanke understands what the consequences of those actions are.
In early September the world price of wheat rose to over $400 a tonne, the highest ever recorded. In May it had been around $200. Though in real terms its price is far below the heights it scaled in 1974, it is still twice the average of the past 25 years. Earlier this year the price of maize (corn) exceeded $175 a tonne, again a world record. It has fallen from its peak, as has that of wheat, but at $150 a tonne is still 50% above the average for 2006.
Rice prices have hit records this year, although their rise has been slower. The Economist's food-price index is now at its highest since it began in 1845, having risen by one-third in the past year.
Food prices are spiking higher. Energy prices hit all-time record highs earlier this year. Health insurance costs rising twice as fast as your paycheck.
The only things that aren't rising in price faster than you can afford them is stuff made in east Asia, where those countries have pegged their currency to the dollar.
Meanwhile, the dollar is near all-time lows.
Is there a connection between the price of things you need rising out of control, and the falling dollar?
YES! Just look at Ben Bernanke's quote above.
This is his plan. It is happening just like he said it would.
Why would he do something like that, you ask? Why would he make it so hard on working people like you and me?
I refer back to part 1 of this diary - the credit crunch and hard times on Wall Street.
The rich get richer and the poor get screwed
The important thing to remember with monetary inflation is that there is a delay between the introduction of the new money and the inevitable price inflation that follows. How long the delay is depends on many things, including the size of the market.
But one thing is for certain: the nearer you are to the source of monetary inflation the more you benefit because you can take advantage of the new money before its effects get diluted by the trailing price inflation.
To look at it another way, Wall Street investment bankers are next door to the primary source of monetary inflation at the Federal Reserve, while wage earners in Detroit and Dallas are the furthest away. Thus wealth is being sucked from the poor and middle class to the rich every time the Federal Reserve and government inject cheap money into the financial system.
The reason for these massive loans to troubled private banks is to avoid a complete seizing up of the world's financial system. It doesn't appear to be working.
"Liquidity doesn't do anything in this situation," says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression.
"It cannot deal with the underlying fear that lots of firms are going bankrupt. The banks and the hedge funds have not fully acknowledged who is in trouble. That is the critical issue," she adds.
York professor Peter Spencer, chief economist for the ITEM Club, says the global authorities have just weeks to get this right, or trigger disaster.
"They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don't think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park," he adds.
Normally comparisons to 1929 are as worthless and overused as references to Hitler in political debates. But this time there is an element of weight behind the comparison.
That element is reflected in the size of monetary injections by the central banks. Only in times of extreme financial stress do central banks go to measures such as these. The difference this time is that those measures aren't reducing the level of stress in the system.
Not a single junk bond has been issued in Europe since August. Every attempt failed.
Europe's corporate bond issuance fell 66pc in the third quarter to $396bn (BIS data). Emerging market bonds plummeted 75pc.
"The kind of upheaval observed in the international money markets over the past few months has never been witnessed in history," says Thomas Jordan, a Swiss central bank governor.
"We're all going long apples and boxes to sell them in."
- Richard F. Syron, Freddie Mac CEO
Cheap credit is what got us into this mess. If it wasn't for cheap credit/money then all these bad loans would never have been made.
I don't know where this is all headed, nor what the correct solution is. But I do remember a wise old saying: when you find yourself in a hole, stop digging.
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