Bush Economy, Sunday, 21SEP08


It's going to be an interesting Monday. What will happen to world markets
after the pumping of $1.5 _T_rillion US Dollars last week by governments
around the world trying to stabilize a crumbling marketplace?

As of this time/date asian markets are up due to interventions last
Thursday and Friday, European markets are down and the NYSE yet to open.

Is Bush&Co going to continue pumping dollars that do not exist? Are
markets going to be fooled? How deep is the exposure to bad mortgages,
money market accounts, commercial loans, and bank failures that are being
insured, without examination of their balance books, on "the full faith
and credit of the United States government." That's Washington-speak for
"your tax dollars are being gambled that we can make up the losses by or
corporate pirate friends."

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Scrambling to Clean Up After A Category 4 Financial Storm

By Steven Pearlstein
Washington Post Staff Writer
Thursday, September 18, 2008; Page A01

You know you're in a heap of trouble when the lender of last resort
suddenly runs out of money.

Having pumped $100 billion into the banking system and lent $115 billion
more to rescue Bear Stearns and AIG, the Federal Reserve was forced to ask
the Treasury yesterday to borrow some extra money to replenish its
coffers. If there was any good news in that, it was that investors here
and abroad were eager to help out, having decided that the only safe place
to put their money is in U.S. government securities. Indeed, demand was so
brisk at one point yesterday that, for an investor, the effective yield on
a three-month Treasury bill was driven below zero, once the broker's fee
was figured in.

This is what a Category 4 financial crisis looks like. Giant blue-chip
financial institutions swept away in a matter of days. Banks refusing to
lend to other banks. Russia closing its stock market to stop the panicked
selling. Gold soaring $70 in a single trading session. Developing
countries' currencies in a free fall. Money-market funds warning they
might not be able to return every dollar invested. Daily swings of three,
four, five hundred points in the Dow Jones industrial average.

What we are witnessing may be the greatest destruction of financial wealth
that the world has ever seen -- paper losses measured in the trillions of
dollars. Corporate wealth. Oil wealth. Real estate wealth. Bank wealth.
Private-equity wealth. Hedge fund wealth. Pension wealth. It's a painful
reminder that, when you strip away all the complexity and trappings from
the magnificent new global infrastructure, finance is still a confidence
game -- and once the confidence goes, there's no telling when the selling
will stop.

But more than psychology is involved here. What is really going on, at the
most fundamental level, is that the United States is in the process of
being forced by its foreign creditors to begin living within its means.

That wasn't always the case. In fact, for most of the past decade,
foreigners seemed only too willing to provide U.S. households,
corporations and governments all the cheap money they wanted -- and
Americans were only too happy to take them up on their offer.

The cheap money was used by households to buy houses, cars and college
educations, along with more health care, extra vacations and all manner of
consumer goods. Governments used the cheap money to pay for services and
benefits that citizens were not willing to pay for with higher taxes. And
corporations and investment vehicles -- hedge funds, private-equity funds
and real estate investment trusts -- used the cheap financing to buy real
estate and other companies.

Two important things happened as a result of the availability of all this
cheap credit.

The first was that the price of residential and commercial real estate,
corporate takeover targets and the stock of technology companies began to
rise. The faster they rose, the more that investors were interested in
buying, driving the prices even higher and creating even stronger demand.
Before long, these markets could best be characterized as classic bubbles.

At the same time, many companies in many industries expanded operations to
accommodate the increased demand from households that decided that they
could save less and spend more. Airlines added planes and pilots. Retail
chains expanded into new malls and markets. Auto companies increased
production. Developers built more homes and shopping centers.

Suddenly, in early 2007, something important happened: Foreigners began to
lose their appetite for financing much of this activity -- in particular,
the non-government bonds used to finance subprime mortgages, auto loans,
college loans and loans used to finance big corporate takeovers. What
should have happened at that point was that the interest rate on those
loans should have increased, demand for that kind of borrowing should have
decreased, the price of real estate and corporate stocks should have
leveled off, takeover activity should have slowed and companies should
have begun to cut back on expansion.

Mostly, however, that didn't happen. Instead, the Wall Street banks that
originally made these loans before selling them off in pieces decided to
try to keep the good times rolling -- and, significantly, keep the
lucrative underwriting fees pouring in. Some used their own "AAA" credit
ratings to borrow more money and keep the loans on their own balance
sheets or those of "structured investment vehicles" they created to hide
these new liabilities from regulators and investors. Others went back to
the foreigners and offered to insure those now-unwanted takeover loans and
asset-backed securities against credit losses, through the miracle of a
new kind of derivative contract known as the credit-default swap.

As a result, when the inevitable crash finally came, it wasn't only those
unsuspecting foreigners who bought those leveraged loans and asset-backed
securities who wound up taking the hit. It was also their creators -- Bear
Stearns, Merrill Lynch, Citigroup, Lehman Brothers, AIG and others -- who
made the mistake of doubling-down on their credit risk at the very moment
they should have been cutting back.

We are now nearing the end of the rocky process of uncovering the full
extent of the credit losses of the major Wall Street banks and hedge
funds. But as Robert Dugger, an economist and partner in a leading hedge
fund likes to points out, the markets have only just begun to force some
financial discipline on the majority of U.S. households that relied on
borrowed money to maintain their lifestyles.

With nobody willing to finance those lifestyles, there are really only two
choices.

One is to turn to Uncle Sam to keep the economy and the financial system
afloat. Unlike businesses, households and Wall Street firms, the Treasury
can still borrow from foreign banks and investors at incredibly attractive
rates. And by acting as an intermediary, the Treasury and the Federal
Reserve have shown a newfound willingness to use those funds to keep the
housing market and the financial system from totally collapsing.

Last spring, the government borrowed $165 billion to send tax rebates to
households in an effort to boost consumer spending. Now, some Democrats
want to create a new agency that would use money borrowed by the Treasury
to recapitalize troubled financial institutions by buying some of their
unwanted loans and securities at discounted prices. The same strategy was
used successfully during the Great Depression and the savings and loan
crisis of the 1990s, and even some Republicans are warming to the idea.

In the end, however, there is only so much the government can borrow and
so much the government can do. The only other choice is for Americans to
finally put their spending in line with their incomes and their need for
long-term savings. For any one household, that sounds like a good idea.
But if everyone cuts back at roughly the same time, a recession is almost
inevitable. That's a bitter pill in and of itself, involving lost jobs,
lower incomes and a big hit to government tax revenues. But it could be
serious trouble for regional and local banks that have balance sheets
loaded with loans to local developers and builders who will be hard hit by
an economic downturn. Think of that, says Dugger, as the inevitable second
round of this financial crisis that, alas, still lies ahead.

--
Regards, Curly
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The Bush Doctrine: Privatize Profits, Socialize Losses
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