Dangerous Unintended Consequences
by Martin D. Weiss, Ph.D.
Dear Subscriber,
I've just returned from Washington, DC, where I held a press conference at the
National Press Club and a round-robin series of meetings with members of
Congress ... with more to come this week.
Let me first tell you what I told them. Then, I'll explain what I think you
should do about it ...
Why Banking Bailouts, Buyouts, and Nationalizations
Can Only Prolong America's Second Great Depression
And Weaken Any Subsequent Recovery
(Edited Transcript of Press Conference Presentation)
The
Fed Chairman, the Treasury Secretary and Congress have now done more to
bail out financial institutions and pump up financial markets than any
of their counterparts in history.
But it's not nearly enough — and, at the same time, it's already far too much.
Two years ago, when major banks announced multibillion-dollar losses in
subprime mortgages, the world's central banks injected unprecedented amounts of
cash into the financial markets.
But that was not enough.
Six months later, when Lehman Brothers and AIG fell, the U.S. Congress rushed
to pass the TARP, the greatest bank bailout legislation of all time.
But as it turned out, that wasn't sufficient either.
Subsequently,
in addition to the original goal of TARP, the U.S. government has
loaned, invested, or committed $400 billion to nationalize the world's
two largest mortgage companies ... $42 billion for the Big Three auto
manufacturers ... $29 billion for Bear Stearns, $185 billion for AIG, and $350
billion for Citigroup ... $300 billion for the Federal Housing Administration
Rescue Bill ... $87 billion to pay back JPMorgan Chase for bad Lehman Brothers'
trades ... $200 billion in loans to banks under the Federal Reserve's Term
Auction Facility (TAF) ... $50 billion to support short-term corporate IOUs
held by
money market mutual funds ... $500 billion to rescue various credit
markets ... $620 billion in currency swaps for industrial nations ... $120
billion in swaps for emerging markets ... trillions to cover the FDIC's new,
expanded bank deposit insurance, plus trillions more for other sweeping
guarantees.
And it STILL wasn't enough.
If
it had been enough, the Fed would not have felt compelled this week to
announce its plan to buy $300 billion in long-term Treasury bonds, an
additional $750 billion in agency mortgage backed securities, plus $100 billion
more in Fannie Mae and Freddie Mac paper.
Total
tally of government funds committed to date: Closing in on $13
trillion, or $1.15 trillion more than the tally just hours ago, when
the body of this white paper was printed.
And yet, even that astronomical sum is still not enough!
Why not? Because of a series of very powerful reasons:
First, most of the money is being poured into a virtually bottomless pit. Even
while Uncle Sam spends or lends hundreds of billions, the wealth
destruction taking place at the household level in America is occurring
in the trillions — $12.9 trillion vaporized in real estate, stocks, and
other assets since the onset of the crisis, according to the Fed's
latest Flow of Funds.
Second,
most of the money from the government is still a promise, and even much
of the disbursed funds have yet to reach their destination. Meanwhile,
all of the wealth lost has already hit home — literally, in the
household.
Third, the government has been, and is, greatly underestimating the magnitude
of this debt crisis. Specifically,
The
FDIC's "Problem List" of troubled banks includes only 252 institutions
with assets of $159 billion. However, based on our analysis, a total of
1,568 banks and thrifts are at risk of failure with assets of $2.32
trillion due to weak capital, asset quality, earnings, and other
factors. (The details are in Part I of our white paper, and the
institutions are named in Appendix A.)
When Treasury officials first planned to provide TARP funds to Citigroup,
they assumed it was among the strong institutions and that the funds
would go primarily toward stabilizing the markets or the economy. But
even before the check could be cut, they learned that the money would
have to be for a very different purpose: an emergency injection of
capital to prevent Citigroup's collapse. Based on our analysis,
however, Citigroup is not alone. We could witness a similar outcome for
JPMorgan Chase and other major banks. (See Part II of our white paper.)
AIG is big. But it, too, is not alone. Yes, in a February 26 memorandum, AIG
made the case that its $2 trillion in credit default swaps (CDS) would have
been the big event that could have caused a global
collapse. And indeed, its counterparties alone have $36 trillion in
assets. But AIG's CDS portfolio is just one of many: Citibank's
portfolio has $2.9 trillion, almost a trillion more than AIG's at its
peak. JPMorgan Chase has $9.2 trillion, or almost five times more than
AIG. And globally, the Bank of International Settlements reports a total of
$57.3 trillion in credit default swaps, more than 28 times larger than AIG's
CDS portfolio.
Clearly, the money available to the U.S. government is too small for a crisis
of these dimensions.
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Fourth, but at the same time, the massive sums being committed by the U.S.
government are also too much:
In
the U.S. banking industry, shotgun mergers, buyouts, and bailouts are
accomplishing little more than shifting their toxic assets like DDT up
the food chain.
And the government's promises to buy up the
toxic paper have done little more than encourage banks to hold on,
piling up even bigger losses.
But the money spent or
committed by the government so far is also too much for another,
relatively less-known reason: Hidden in an obscure corner of the derivatives
market is a unique credit default swap that virtually no one is talking about
— contracts on the default of United States Treasury bonds. Quietly and
without fanfare, a small but growing number of investors are not only
thinking the unthinkable, they're actually spending money on it,
bidding up the premiums on Treasury bond credit default swaps to 14 times their
2007 level. This is an early warning of
the next big shoe to drop in the debt crisis — serious potential damage
to the credit, credibility, and borrowing power of the United States
Treasury.
This trend packs a powerful message — that there's no
free lunch; that it's unreasonable to believe the U.S. government can
bail out every failing giant with no consequences; and that, contrary
to popular belief, even Uncle Sam must face his day of reckoning with
creditors.
We view this as a positive force. We are optimistic
that, thanks to the power of investors, creditors, and the people of
the United States, we will ultimately guide, nudge, and push ourselves
to make prudent and courageous choices:
1. We will back off from
the tactical debates about how to bail out institutions or markets, and
rethink our overarching goals. Until now, the oft-stated goal has been
to prevent a national banking crisis and avoid an economic depression. However,
we will soon realize that
the true costs of that enterprise — the 13-digit dollar figures and
damage to our nation's credit — are far too high.
2. We will
replace the irrational, unachievable goal of jury-rigging the economic
cycle with the reasoned, achievable goal of rebuilding the economy's
foundation in preparation for an eventual recovery.
Right now,
the public knows intuitively that a key factor which got us into
trouble was too much debt. Yet the solution being offered is to
encourage banks to lend more and people to borrow more.
Economists almost universally agree that one of the grave weaknesses of our
economy is the lack of savings needed for healthy capital formation,
investment in better technology, infrastructure, and education. Yet the
solution being offered is to spend more and, by extension, to save less.
These disconnects will not persist. Policymakers will soon realize they have to
change course.
3.
When we change our goals, it naturally follows that we will also change
our priorities — from the battles we can't win to the war we can't
afford to lose. Right now, for example, despite obviously choppy seas,
the prevailing theory seems to be that "the ship is unsinkable" or that
"the government can keep it afloat no matter how bad the storm may be."
With
that theory, they might ask: "Why have lifeboats for every passenger?
Why do much more for hospitals which are laying off ER staff, for
countless charities that are going broke, or for the one in fifty
American children who are now homeless? Why prepare for the financial
Katrinas that could strike nearly every city?"
The correct
answer will be: Because we have no other choice; because that's a war
we can and will win. It will not be very expensive. We have the
infrastructure. And we'll have plenty of volunteers.
4. Right
now, our long-term strategies and short-term tactics are in conflict.
We try to squelch each crisis and kick it down the road. Then, we do it
again with each new crisis. Meanwhile, fiscal reforms are talked up in
debates, but pushed out in time. Regulatory changes are mapped out in
detail, but undermined in practice. Soon, however, with more
reasonable, achievable goals, theory and practice will fall into synch.
5.
Instead of trying to plug our fingers in the dike, we're going to guide
and manage the natural flow of a deflation cycle to reap its
silver-lining benefits — a reduction in burdensome debts, a stronger
dollar, a lower cost of living, a healthier work ethic, a better
ability to compete globally.
6. We're going to buffer the
population from the most harmful social side-effects of a worst-case
scenario. Then, we're going to step up, bite the bullet, pay the
penalty for our past mistakes, and make hard sacrifices today that
build a firm foundation for an eventual economic recovery. We will not
demand instant gratification. We will sacrifice our lifestyle today to
assume responsibility for our future and the future of our children.
7. We will cease the doubletalk and return to some basic axioms, namely that:
The
price is the price.. Once it is established that our overarching goal is
to manage — not block — natural economic cycles, it will naturally
follow that regulators can guide, rather than hinder, a market-driven
cleansing of bad debts. The market price will not frighten us. We can use it
more universally to value assets.
A
loss is a loss. Whether an institution holds an asset or sells an
asset, whether it decides to sell now or sell later, if the asset is
worth less than what it was purchased for, it's a loss.
Capital is capital. It is not goodwill or other intangible assets that are
unlikely to ever be sold. It is not tax advantages that may never be reaped.
A
failure is a failure. If market prices mean that institutions have big
losses, and if the big losses mean that capital is gone, then the
institution has failed.
8. We will pro-actively shut down the
weakest institutions no matter how large they may be; provide
opportunities for borderline institutions to rehabilitate themselves
under a slim diet of low-risk lending; and give the surviving,
well-capitalized institutions better opportunities to gain market share.
Kansas
City Federal Reserve President Thomas Hoenig recommends that "public
authorities would be directed to declare any financial institution
insolvent whenever its capital level falls too low to supports its
ongoing operations and the claims against it, or whenever the market
loses confidence in the firm and refuses to provide funding and
capital. This directive should be clearly stated and consistently
adhered to for all financial institutions that are part of the
intermediation process or payments system." We agree.
9.
We will build confidence in the banks, but in a very different way.
Right now, banking authorities are their own worst enemy. They paint
the entire banking industry with a single broad brush — "safe." But
when consumers see big banks on the brink of bankruptcy, their response
is to paint the entire industry with another broad brush — "unsafe." To
prevent that outcome, we will challenge the authorities to release
their confidential "CAMELS ratings"
on each bank in the country. And we will ask them to reverse the
expansion of FDIC coverage limits, restoring the $100,000 cap for
individuals and businesses.
Although these steps may hurt
individual banks in the short run, it will not harm banks in the long
run. Quite the contrary, when consumers can discriminate rationally
between safe and unsafe institutions, and when they have a motive to
shift their funds freely to stronger hands, they will strengthen the
nation's banking system.
I am making these recommendations
because I am optimistic we can get through this crisis.. Our social and
physical infrastructure, our knowledge base, our democratic form of government
are strong enough to do so. As a nation, we've been through worse
before, and we survived then. With all our wealth and knowledge, we can
certainly do it again today.
But my optimism comes with no
guarantees. Ultimately, we're going to have to make a choice: The right
choice is to make shared sacrifices, let deflation do its work, and
start regenerating the economic forces that have made the United States
such a great country. The wrong choice is to take the easy way out, try
to save most big corporations, print money without bounds, debase our
dollar, and ultimately allow inflation to destroy our society.
This
white paper is my small and humble way of encouraging you, with data
and reason, to make the right choice starting right now.
What You Must Do Now
There
followed a vigorous debate and some of the most unique questions I've
had the honor to answer in many years. (I'll share them with you when I
have the transcript.)
In the meantime, here's what I recommend you do:
Step 1. As soon as you have a chance, take a look at our white paper on the
banking crisis.
Step
2. In Part II (where I list a few big banks) and in the appendix, where
I have all the rest of the banks and thrifts we believe are at risk of
failure, make sure yours is not on it.
Step 3. If it is, I
recommend shifting to a stronger institution, regardless of the size of
the bank or the size of your account.
Step 4. For our list of
the strongest banks in the U.S., plus instructions on where to find
even safer havens for your money, see our free report available to all
Money and Markets members.
Step 5. Most important, stand by for
my appeal for help! I can't do this alone. I will need your support,
and I'll explain exactly how soon.
Good luck and God bless!
Martin
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