USA Full-Spectrum Breakdown


On Friday morning, Senator Christopher Dodd, the head of the Senate
Banking Committee, was interviewed on ABC's “Good Morning America.”
Dodd revealed that just hours earlier at an emergency meeting convened
by Secretary of the Treasury Henry Paulson and Federal Reserve
chairman Ben Bernanke, lawmakers were told that "We’re literally
maybe days away from a complete meltdown of our financial system.”
Dodd added somberly, that in his three decades of serving in public
office, he had "never heard language like this.”

The system is at the breaking point, and despite Wall Street's elation
from the proposed $1 trillion dollar bailout to remove toxic mortgage-
backed debt from banks balance sheets, the market is still correcting
in what has become a vicious downward cycle. This cycle will persist
until the bad debts are accounted for and written off for or until the
exhausted dollar-system collapses altogether. Either way, the
volatility and violent dislocations will continue for the foreseeable

Most people don't understand what happened on Thursday, but the build-
up of bad news on the Lehman default and the $85 billion government
takeover of AIG, triggered a run on the money markets and a freeze in
interbank lending. The overnight LIBOR rate (London Interbank Offered
Rate) more than doubled to 6.44 per cent. Bank of America reported
overnight borrowing rates in excess of 6 per cent. Longer-term LIBOR
rates also rose sharply. On Wednesday, jittery investors removed their
money from money markets and flooded short-term US Treasurys for the
assurance of a government guarantee on their savings even though
interest rates had turned negative which means that their balance
would actually shrink at the date of maturity. This is unprecedented,
but it does help to illustrate how raw fear can drive the market.

The TED spread (the TED Spread measures market stress by revealing the
reluctance of banks to lend to each other) widened and the credit
markets froze in place. Borrowing three-month dollars on the interbank
market and the U.S. Treasury's three-month borrowing costs widened
five full percentage points. That's huge. The banking system shut

What does it mean? It means the Federal Reserve has lost control of
the system. The market is driving interest rates now, and the market
is terrified. End of story.

When the Fed announced its emergency program to dump $180 billion into
the global banking system, short term Libor retreated slightly but
long-term rates have remained stubbornly high. The noose continues to
tighten. These rates are pinned to 6 million US mortgages which will
be resetting in the next few years. That's more bad news for the
housing industry.

The entire system is deleveraging with the ferocity of a Force-5 gale
touching down in the Gulf, and yet, Henry Paulson has decided that the
prudent thing to do is build levees around the system with paper
dollars. Naturally, many people who understand the power of market-
corrections are skeptical. It won't work. Libor is pushing rates
upwards--that's the "true" cost of money. The Fed Funds rate (2 per
cent) is supported by infusions of paper dollars into the banking
system to keep interest rates artificially low. Now the extreme pace
of deleveraging has the Fed on the ropes. Trillions of dollars of
credit is being sucked into a black hole which is raising the price of
money. It's out of Bernanke's control. He needs to step out of the way
and let prices fall or the dollar system will vanish in a deflationary

The problems cannot be resolved by shifting the debts of the banks
onto the taxpayer. That's an illusion. By adding another $1 or $2
trillion dollars to the National Debt, Paulson is just ensuring that
interest rates will go up, real estate will crash, unemployment will
soar, and foreign central banks will abandon the dollar. In truth,
there is no fix for a deleveraging market anymore than there is a fix
for gravity. The belief that massive debts and insolvency can be
erased by increasing liquidity just shows a fundamental
misunderstanding of economics. That's why Henry Paulson is the worst
possible person to be orchestrating the so called rescue project.
Paulson comes from a business culture which rewards deception,
personal acquisitiveness, and extreme risk-taking. Paulson is to
finance capitalism what Rumsfeld is to military strategy. His
leadership, and the congress' pathetic abdication of responsibility,
assures disaster. Besides, why should the taxpayers be happy that the
stocks of Morgan Stanley, Washington Mutual and Goldman Sachs surged
on the news that there would be a government bailout yesterday? These
banks are essentially bankrupt and their business models are broken.
Keeping insolvent banks on life support is not a rescue plan; it's

No one has any idea of the magnitude of the deleveraging ahead or the
size of the debts that will have to be written down. That's because 30
years of deregulation has allowed a parallel financial system to arise
in which over $500 trillion dollars in derivatives are traded without
any government supervision or accounting. These counterparty
transactions are interwoven throughout the entire "regulated" system
in a way that poses a clear and present danger to the broader economy.
It's a mess. For example, there are an estimated $62 trillion of
Credit Default Swaps (CDS) alone, which are basically insurance
policies for defaulting bonds. AIG was as heavily involved in CDS as
they were in regulated insurance products. So why would AIG sell CDS
rather than conventional insurance?

Because, just like the banks, AIG could maximize its profits by
minimizing its capital cushion. In other words, it didn't really have
the capital to pay off claims when its CDS contracts began to blow up.
If it had been properly regulated, then government regulators would
have made sure that it was sufficiently capitalized with adequate
reserves to pay off claims in a down-market. Now taxpayers will pay
for the lawless system which men like "industry rep" Henry Paulson put
in place. That's deregulation in a nutshell; a system that allows Wall
Street banksters to create credit out of thin air and then run weeping
to Congress when their swindles backfire.

Inflating the currency, printing more money, and increasing the
deficits won't help. The bad debts have to be accounted for and
liquidated. The Paulson strategy is to create another ocean of red ink
while refusing to face the underlying problem head-on. This just
further exacerbates the consumer-led recession which economists know
is already setting in everywhere across the country. Demand is down
and consumer spending is off due to falling home equity, job losses,
and tighter lending standards at the banks. The broader economy does
not need the added downward pressure from higher taxes, bigger
deficits, or inflation. Paulson's plan is a band-aid approach to a
sucking chest wound. The debts are enormous and the pain will be
substantial, but the problem cannot be resolved by crushing the middle
class or destroying the currency.

The malfunctioning of the markets and the freeze-over in the banking
system are the outcome of a massive credit unwind instigated by
trillions of dollars of low interest credit from the Federal Reserve
which was magnified many times over via complex derivatives contracts
and extreme leveraging by speculative investment bankers. This has
generated the biggest equity bubble in history. That bubble is now set
for a "hard-landing" which is the predictable result of an
unsupervised marketplace where individual players are allowed to
create as much credit as they choose.

Mike Whitney lives in Washington state. He can be reached at


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