Sun Post #2: Why Central Banks won't be able to stop the systemic risk crisis emerging in Europe

Those who have followed this blog over the past few years know there is one theme that we repeat ad nauseam: the 2008 Financial Crisis was an earthquake the depth and breadth of which none of us fully understand nor appreciate.

And that crisis is not over.

Yesterday Graham Summers of Phoenix Capital Research had this take on the current state of the Financial Crisis that emerged in 2008.

Summers believes events in Europe will escalate and that Europe will collapse before the end of the year and very likely before the end of the summer. When this plays out, the fallout will be worse than 2008.

And the world Central Banks will not be able to control the damage.

Summers thinks the Crisis coming from Europe will be far, far larger in scope than anything the US Federal Reserve has dealt with before.

He also thinks the Fed is now politically toxic and cannot engage in aggressive monetary policy without experiencing severe political backlash (this is an election year).

The Fed’s resources are spent to the point that the only thing the Fed could do would be to announce an ENORMOUS monetary program which would cause a Crisis in of itself.

Summers breaks down the key facts:

• According to the IMF, European banks as a whole are leveraged at 26 to 1 (this data point is based on reported loans… the real leverage levels are likely much, much higher.) These are a Lehman Brothers leverage levels.
• The European Banking system is over $46 trillion in size (nearly 3X total EU GDP).
• The European Central Bank’s (ECB) balance sheet is now nearly $4 trillion in size (larger than Germany’s economy and roughly 1/3 the size of the ENTIRE EU’s GDP). Aside from the inflationary and systemic risks this poses (the ECB is now leveraged at over 36 to 1).
• Over a quarter of the ECB’s balance sheet is PIIGS debt which the ECB will dump any and all losses from onto national Central Banks (read: Germany)
• It means we’re talking about a banking system that is nearly four times that of the US ($46 trillion vs. $12 trillion) with at least twice the amount of leverage (26 to 1 for the EU vs. 13 to 1 for the US), and a Central Bank that has stuffed its balance sheet with loads of garbage debts, giving it a leverage level of 36 to 1.

And all of this is occurring in a region of 17 different countries none of which have a great history of getting along… at a time when old political tensions are rapidly heating up.

As bad as the above points may be, they don’t even come close to describing the REAL situation in Europe.

Case in point, regarding leverage levels, PIMCO’s Co-CIO Mohammad El-Erian (one of the most connected insiders in the financial elite) recently noted that French banks (not Greece or Spain) currently have 1-1.5% capital relative to their assets, putting them at leverage levels of nearly 100-to-1.

And that’s France we’re talking about: one of the alleged key backstops for the EU as a whole.

The Federal Reserve, indeed, Global Central Banks in general, have never had to deal with a problem the size of the coming EU’s Banking Crisis. There are already signs that bank runs are in progress in the PIIGS and now spreading to France (see El-Erian’s comments in the article above).

Summers observes the EU is a colossal mess beyond the scope of anyone’s imagination. The World’s Central Banks cannot possibly hope to contain it. They literally have one of two choices:

1. Monetize everything (hyperinflation)
2. Allow the defaults and collapse to happen (mega-deflation)

If they opt for #1, Germany will leave the Euro. End of story. So even the initial impact of a massive coordinated effort to monetize debt would be rendered moot as the Euro currency would enter a free-fall, forcing the US dollar sharply higher which in turn would trigger a 2008 type event at the minimum.

Moreover, Summers observes the Fed is now so politically toxic that Ben Bernanke is literally going on the campaign trail to attempt to convince the American people that the Fed is an honest and helpful organization. Put another way, there is NO CHANCE the Fed can announce a large-scale monetary policy unless a massive Crisis hits and stocks fall at least 15%.

Finally if the Fed were to announce a new policy it would have to be MASSIVE, as in more than $2 trillion in scope.

Summers points out that the $600 billion spent during QE 2 barely bought three months of improved economic data in the US and that was a pre-emptive move by the Fed (the system wasn’t collapsing at the time).

So Summers concludes that given that the Fed will only be able to announce a large scale program in reaction to a Crisis, whatever it did announce would have to be ENORMOUS, a kind of shock and awe, attempt to rein in the markets.

Moreover, it would literally be THE LAST QE the Fed could hope to ever announce as political outrage from the ensuing Dollar collapse and inflationary pressures would likely see the open riots and/or the Fed dismantled (this has happened twice before in the US’s history).

In simple terms, the Fed’s hands are tied until a huge Crisis hits.

And then, if the Fed acts it’s going to have to go “all in” with a massive program. If it does, we will still experience a Crisis, as the Dollar would collapse pushing inflation through the roof as well as interest rates (which in turn would destroy the banks as well as the US economy).

In simple terms Summers believe that, this time around, when Europe goes down (and it will) it’s going to be bigger than anything we’ve seen in our lifetimes. And this time around, the world Central Banks are already leveraged to the hilt having spent virtually all of their dry powder propping up the markets for the last four years.

Most people believe the Fed can just hit “print” and solve everything, but Summers believes they’re wrong.

The last time the Fed hit “print” food prices hit records and revolutions began spreading in emerging markets. If the Fed does it again, especially in a more aggressive manner as it would have to, we would indeed enter a dark period in the world and the capital markets.

Country	GDP
European Union	$16 trillion
United States of America	$14.5 trillion
China	$5.8 trillion
Japan	$5.4 trillion
European Central Bank	$3.8 trillion
Germany	$3.2 trillion
US Federal Reserve	$2.8 trillion
France	$2.5 trillion
United Kingdom	$2.2 trillion

Banking System	Total Assets	Total Assets Relative to GDP	Total Assets Relative to Central Bank Balance Sheet
Europe	$46 trillion	287%	1,210%
US	$12 trillion	82%	428%

Summers insists this is not Doom and Gloom, it's reality.

Graham Summers isn't the only one with this view.

World renown investor George Soros is singing a similar tune.

Germany and its central bank are unlikely to lead the way out of the euro zone debt crisis within three months time, after which it will be too late, U.S. billionaire George Soros said on Saturday.


Speaking at an economic conference in Trento, Italy, Soros said that the euro crisis - which he defined as a sovereign debt crisis and a banking crisis closely interlinked - threatened to destroy the European Union and plunge it into a lost decade like Latin America in the 1980s.


The Greek crisis is liable to come to a climax in the fall. By that time the German economy will also be weakening so that Chancellor (Angela) Merkel will find it even more difficult than today to persuade the German public to accept any additional European responsibilities. That is what creates a three-month window," he said.

As I have stated many times, this crisis is far from over.

The Central Banks of the world will not permit the massive deleveraging  and destruction of debt that must occur for the capitalist system to repair itself.

So it MUST intervene.

Mark Zandi, chief economist at Moody’s Analytics, said yesterday that President Obama will not let Europe fail.

"Europe is the key swing factor. If Europe addresses its financial troubles, and keeps Greece in the eurozone, the financial markets are likely to settle and boost U.S. employers’ confidence. But if Europe slowly worsens, it will be a drag on the U.S. economy."

I tend to agree with Grant Williams who says

as we approach the endgame for Europe, the choice facing those empowered to make decisions about how it ultimately plays out is actually a fairly simple one—allow massive, widespread sovereign defaults and a continent-wide bank-run or print unlimited amounts of Euros... is anyone still confused about how this will all play out?

Europe’s ‘leaders’ will NOT arbitrarily choose to inflict the pain necessary to deal with the current debt crisis when they have the means to print free money at their disposal and the only impediment to doing so is an as-yet undetermined percentage of 81 million German citizens.

If Germany has to leave the EU in order for the moneyprinting to happen, then they will leave - either because they choose to or because the ‘Latin-bloc’ (which now includes France) forces them to. Either way, the end will come in a shower of confetti paper money.

There may well be a period of deflation or deleveraging prior to inflation taking hold, but with inflation the central bankers’ firehose of choice, we can be fairly certain that inflation is in our future.

Because the Central Banks MUST intervene, I believe tremendous opportunity lies ahead in terms of Gold and Silver, especially Silver.

I don't believe the world will return to a Gold Standard, nor should it. But there will be a tremendous flight to both Gold and Silver as this plays out, even while other commodities collapse.

And that represents a huge opportunity.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

The Greek Issue

If you've been following the European debt situation lately you know the whole Greece issue is a constant 'on-again-off-again' soap opera as to whether an agreement has been reached to resolve the crisis.

And after the latest 'agreement', Greece is back in the news requiring more money.

It raises the spectre of whether or not a Greek default will occur.

Some have speculated there will be a default and it will destroy the Big 5 US Banks because of their derivative exposure.

That won't happen, but you may be surprise to find out why... and how this is just the tip of the iceberg on the European debt issue .

No one is really sure what happens in the credit default swap CDS markets.

No one really knows how big this market is, who the counterparties are, and, worst of all, whether the CDS contracts will actually trigger in what many would consider a default.

I say "what many would consider a default" because you are going to see any agreement in this issue ruled 'not-a-default'.

Up to now, most of the media discussion has centered on potential contagion among the banks as most of the Greek sovereign debt is held by the European banking community (and numerous hedge funds).

But the real fear amongst those who follow the situation is that the real concern lies in the area of credit default swaps (CDS).

The swaps are insurance policies, individually written, that basically say - if Greece defaults, we’ll pay you what Greece should have paid you.

Credit default swaps have grown exponentially over the last decade. Since they are individually written, there is no clear visible record of how many CDS contracts are outstanding. Also unknown is who is involved. The two parties obviously know who the counter-party is but there is no public record that would allow a regulator or a third party to find out who was involved.

What is known is that the Big 5 US Banks have sold the vast majority of this insurance, insurance which has been a cash-cow for those banks and largely responsible for those obscene Wall Street bonuses we hear so much about.

As Greece debt came up for sale, Banks and others looked at the very high and attractive yields on those Greek bonds and salivated as they bought them up.

As for the risk involved?... well, they bought insurance to protect themselves.

Then the 2008 financial crisis hit.

As the world wide economy imploded, the house of cards of sovereign debt in Europe began to collapse.

Portugal, Ireland, Italy, Spain and Greece (the PIIGS) were at the forefront of the crisis.

And lately Greece has been getting all the attention.

As negotiators on the Greek debt problem attempted to work out a solution to Greece's debt crisis, they asked the debt holders to agree to take, first 70 cents on the dollar for the debt owned to them and now 50 cents.

It was termed a 'haircut' on their investments (cutsie way of saying you're going to lose money).

But would that 'haircut' trigger their Credit Default Swap (the insurance they bought to protect them if Greece didn't pay back the full amount of the bond)?

On the face of it, it seems pretty clear. They have CDS insurance to ensure they get all their money back, Greece can't pay, insurance will cover the difference - right?

Well... not so fast.

Five of the largest US banks control 97% of all the credit default swaps.

And the total amount of these swaps and derivatives is in the hundreds of Trillions of dollars (yes... that's Trillions with a capital 'T'). JP Morgan alone holds over $60 Trillion in these derivatives.

Jim Sinclair, a precious metals and commodities trader since 1977 who has worked as am Executive member in two major Wall Street firms on the New York Stock Exchange, has discussed this issue in depth. Since the five largest US banks control 97% of all credit default swaps, a demand of payment on those derivatives would instantly wipe out these financial institutions.

Therefore it is imperative that any 'agreement' on how to deal with these bonds (and Greece's inability to deal with not paying them) cannot be determined a 'default'.

Enter the International Swaps and Derivatives Association Inc (ISDA). This is a trade organization of participants in the market for over-the-counter derivatives. Its membership consists of derivatives dealers, service providers and end users and they are the organization who make official, binding determinations regarding the existence of "credit events" and "succession events" (such as mergers), which may trigger obligations under a credit default swap contract.

In short the ISDA are the people who determine whether a credit event is a default or not.

The only problem is that the ISDA is heavily influenced (if not largely controlled by) the very big 5 US banks who hold 97% of the credit default swaps that are in question here.

If the ISDA rules that a 'credit event' (or default) has occurred in the Greek issue, the big 5 US Banks will be insolvent and wiped out. Wiping out these banks would wipe out the US Banking system.

Therefore you can be rest assured the ISDA will NEVER allow a 'legal' default on this debt.

That's why you keep hearing about negotiations on the Greece issue where bondholder's are being forced to accept 'haircuts' on their bonds.

The contention is that if the bondholder's "accept" the offer of 50 cents on the dollar, they make the event voluntary and it will not "trigger" the CDS payout.

These requests for a 'haircut' have caused lots of folks to ask for a ruling from the ISDA (the ruling group on CDS contracts). If you "accepted" an offer with a gun to your head, was it really voluntary?

Naturally the ISDA will rule that it is and therefore the CDS contracts are not triggered.

As Jim Sinclair contends the bondholders could be forced to accept 0%, the ISDA will never rule that a default because the big 5 US Banks cannot be placed in a position to pay out this insurance.

For those who think Greece will default later next month, it's not going to happen - legally happen that is.

The bondholders may be forced to lose everything, but the Big 5 US banks won't be forced to pay out on these derivatives and CDS contracts because the ISDA will never rule this issue a default.

The real focus is on what comes next.

This is what you should be watching in Europe.

In 2008, AIG had sold Credit Default Swaps (CDS) on Credit Default Obligations (CDOs). CDOs defaulted and AIG had to pay. AIG went broke. The counterparties to the CDS were Goldman Sachs, JP Morgan et al and had to be made whole on their losses that they thought were insured by AIG.

It was a crisis which could have brought down the US banking system.

In response the US Government intervened and funneled TARP cash thru AIG to Goldman Sachs, JP Morgan et al to cover losses

IN 2012, Greece is about to default, just like the CDOs of 2008.

The ISDA (controlled by the Big 5 banks) will rule that any haircut on Greek bonds is not a default. Therefore the Big 5 Banks will never have to pay off on CDOs bought by Greek bondholders.

But the Greek bondholders, who thought they had principal insurance, are now screwed and are left holding the bag.

This is what caused MF Global to go under when the first Greek 'haircut' was not ruled a default.

Those Greek bondholders (the big Euro banks, big Euro govts, big hedge funds) will now be insolvent. They are going to require massive capital injection.

As those CDS contracts do not kick in, the next phase begins to unwind.

What good is insurance that doesn’t pay off? Does it mean all CDS insurance is useless? Who will be the next to fail because the insurance they thought was protecting them isn't going to pay out?

As you have read on this blog ad nauseum. The 2008 Financial Crisis was a financial earthquake, the repercussions of which many of us still do not understand nor appreciate.

That's why the big 8 Central Banks of the world have been involved in another round of massive money printing - to try and save Greek bondholders. And the level of money printing has only just begun.

As I have said, we are still only beginning to realize how profound and far reaching the 2008 Financial Crisis really is.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

It will be complete chaos

You've seen me say it before. And I will say it again... the financial crisis of 2008 was a profound earthquake, the reprecussions of which we still do not fully appreciate.

The aftershocks continue.

Yesterday the German government announced they were banning short-selling of the banks or betting against bonds.

They are doing this because they think the financial crisis is going to get worse.

And, as this article from the Telegraph notes, the response of the markets is expected to be extreme. Traders greeted the move with a mixture of anger and astonishment.One bond trader said he expected Wednesday's trading session to be one of the most volatile in living memory:

"It will be complete chaos, I really don't know what the Germans think they are doing... Without the two-way flow the German market is likely to become utterly dysfunctional... and it raises the long-term question of who is now going to want to buy their debt.""

Will German bonds (called Bunds) collapse today?

The story of the decade will be sovereign debt, a tale which will ultimately drive interest rates sky high.

==================

Email: village_whisperer@live.ca

Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

Fry?... Fry?... Fry?...

This will be the third post in our series this week.

Post #1 can be read here. Post #2 can be read here.

Yesterday we ended by noting that governments in the western world had responded to the 2008 Financial Crisis by liquefying the system beyond any rational explanation, more than doubling the monetary base since the collapse of Lehman Brothers.

The debt obligations of the financial system have now been passed onto government.

For the United States this is no small issue, because it is being piled onto an already massive pile of debt.

Many people don’t understand how money is created. Most, mistakenly, think that the United States simply prints up some more cash as needed.

It doesn’t.

The US Federal Reserve Bank is a private institution owned and controlled by private banks. It is a private bank that enriches its private owners.

As for regular banks, they do not make loans only from money they have on deposit. Through what is called "fractional reserve banking," They loan well over ten times the amount they have on deposit.

So where does the money come from?

The Federal Reserve Bank buys $10,000 of US debts called Treasury Bills from the US. Where does the Fed get the money? The Fed creates it out of thin air. This is the first bit of magic. This is authorized by the Federal Reserve Act of 1913, and is a questionable delegation by Congress of its own power to "coin money and regulate the value thereof.” It is the ultimate in privatization.

The Fed then loans this $10,000 to a bank and requires the bank to pay the current federal funds rate as interest. This $10,000 becomes a "liability" of the bank, but the bank immediately loans this money to a borrower, but in double entry bookkeeping, this $10,000 loan becomes an "asset" of the bank from which the bank can make further loans. Here is where the second bit of magic occurs called "fractional reserve banking." The reserve is not gold or any other hard asset. The "reserve" is debt.

All debt of the US, all corporate debt, and all individual debt are owed to private banks. All money is debt. And the people of the United States pay interest on that debt.

So when the United States doubled the monetary base, they added massively to the pile of public debt.

And this debt pile faces an avalanche of looming additions.

In the United States, Social Security, which was in balance in year 2000, is now underfunded by $15 trillion dollars.

Total unfunded obligations of the US Government are now $104 trillion.

If we add the $6 trillion of outstanding Fannie Mae and Freddie Mac debt and the $14 trillion of outstanding national debt, we arrive at a total US government debt obligation of $124 trillion.

It’s a truly preposterous amount of money that will never be paid off in today’s dollars.

And how is the United States handling the management of this “debt”?

Anyone who has debt knows that you manage it by paying the interest and paying down the debt. At the end of the month you pay your bills and then take any left over cash, and you put it towards your debt.

The United States currently, at the end of the month, has more bills than income. There isn’t enough to pay the basic bills, let alone pay down the debt. It means at the end of each month, the United States has to ‘borrow’ even more money... and goes deeper in debt. We call this deficit financing.

And as Martin Weiss,PhD, tells us, this deficit financing is reaching a critical stage.

For those of you other there who think that the sovereign debt crisis is mostly behind us... that America’s federal deficit is turning into a non-issue... or that we can just go back to business as usual... you’d better consider the drama now unfolding in the hard numbers just released last week:

In February alone, the official U.S. federal deficit was a monstrous $221 billion, far greater than anything the US has ever experienced in history.

To put this into perspective, back in the 1980s, for example, President Reagan was plagued with the worst string of federal deficits ever recorded until that time. But with February’s deficit, Washington has managed to run up just as much red ink as it did in all of 1986, the single worst deficit year under Reagan.

Going back further, to the 1970s under President Nixon, there was also had a rash of deficit spending that sent chills up the spines of economists. But last month’s deficit of $221 billion was more than TRIPLE the sum total of ALL deficits during the six years under Nixon.

Ever since America’s Declaration of Independence, deficit spending has been a recurring theme in Washington that invariably returns with a vengeance, especially during wartime. But it took 169 long years and seven major wars — from 1776 to 1945 — to rack up a cumulative deficit that matches the gaping budget hole of just 28 short days in February.

This is an unprecedented level of borrowing. And to where does the government resort in order to finance these humongous deficits?

In just one week last month (ending 2/26), the U.S. Treasury issued...

• $32 billion in 7-year Treasury notes,
• $42 billion in 5-year notes,
• $44 billion in 2-year notes,
• $8 billion in 30-year TIPS bonds,
• $26 billion of 3-month bills,
• $28 billion of 6-month bills,
• $31 billion of 4-week bills, and
• $25 billion of cash management bills.

Grand total: $236 billion in government debt issued in a single week, the most in the history of the world.

This means that Uncle Sam borrowed new money — and replaced old debt — at the rate of $390,212 per second … $23.4 million per minute… and $1.4 billion per hour — around the clock!

It is a pace of debt issuance that simply cannot be sustained without disastrous consequences.

One of those consequences is going to be a dreadful crowding out of the private sector. As long as Uncle Sam is continuing to hog most of the available credit, it’s going to be increasingly difficult — sometimes nearly impossible — for most businesses and consumers to get their share of desperately needed funds.

Consider the fourth quarter of last year, for example. The Fed’s Flow of Funds report, just released on Thursday, tells the story...

Government borrowing was massive. The U.S. Treasury jumped into the credit markets and grabbed up new funds at an annual pace of $954.7 billion, while local and state governments raised $114.2 billion. Total government borrowing (after some reduction in gov’t agency bonds): $1,040.4 billion.

In contrast…

Most business borrowers were shoved out of the credit markets: Not only did they have a tough time getting new loans, they also cut down their EXISTING debts — either voluntarily or not — at the breakneck annual pace of $1,097.5 billion.

Millions of consumers were virtually ostracized from the credit market. They were forced to cut their existing mortgages at the annual rate of $365.1 billion and their consumer credit at the rate of $145.3 billion — a total annualized cutback of $510.4 billion.

Don’t underestimate the potential impact of this phenomenon on the economy and your investments.

Remember, We are not just witnessing a decline in new business and consumer borrowing — a trend that typically signals economic weakness. Rather, what we have here is a decline to ZERO on a net basis! Plus… massive pressure on consumers and businesses to actually PAY DOWN debts outstanding! Plus… widespread defaults and foreclosures forcing the lenders to WRITE OFF massive amounts of debts

It’s bad enough when you see credit flowing to consumers and corporations at a slower pace. But what’s happening now is far, far worse! Credit is actually being sucked OUT of the consumer and corporate economy at a torrid pace.

Huge amounts of credit being denied — or even taken away from — those who could fuel a recovery … at the same time, huge amounts of credit being grabbed by federal and local governments to finance their giant deficits.

That’s why everyone is saying the current economic recovery is being bought and paid for by Washington. Which is why a sovereign debt crisis — and future difficulties by governments to continue borrowing — is such a threat.

If the U.S. economy is just limping along now - with massive government support - imagine the paralysis that’s likely to occur if the government cuts back that support in order to curtail out-of-control deficits!

In Greece the day of reckoning has arrived. The bond market vigilantes are forcing the Greek government to deal with their deficit and bring things under control.

That day of reckoning is not too far off for the UK and then it will be the turn of the United States.

Tomorrow we will look at what that means, for both the economy in general and for Canadians in particular.

To read the next part, click here.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

Bueller?... Bueller?... Bueller?...

Today's post is a continuation of a theme started yesterday. If you missed it, start reading here.

The Financial Collapse of 2008

It was the Lehman Brothers bankruptcy on Sept. 15th, 2008 that set the financial collapse of 2008 into motion.

I’m not going to dwell on the whole subprime mortgage situation, instead the focus is on what many people fail to appreciate… the mayhem that took place during the following days in the US money markets.

The day after Lehman’s collapse, the Reserve Fund, one of the oldest and most high profile US money market funds, began to hemorrhage money as investors redeemed in panic.

Large institutional investors soon began pulling money out of other major US money market funds fearing heavy losses from Lehman Brothers debt.

Almost $173 billion was pulled from such funds over the next two days, threatening to collapse the entire US financial system.

Two weeks later, on Sept. 29th, investors sent the Dow Jones plummeting 778 points, representing the largest single-day loss in the history of the index.

In hindsight, it was somewhat of a delayed response, because the real damage had by then been averted by the Treasury’s blanket guarantees on all money market funds.

The main issue is that on Thursday, September 18th, the main people in power in the United States were convinced that the US financial system almost completely collapsed.

The details of that day remain frustratingly murky. The imminence of complete disorder appears to have scared Congress into action, but we can only piece the story together through random anecdotes that have been partially revealed through subsequent interviews.

In what has been dubbed ‘the Kanjorski meme’, Congressman Paul Kanjorski recounts a meeting that was held between Ben Bernanke, Henry Paulson and certain members of Congress where the conception of the "Troubled Asset Relief Program" (TARP) supposedly took place.

To stem the flow of money out of US-based money market funds, Paulson had to provide an almost instant guarantee on all money market funds held within the United States.

Kanjorski recounts, "If they had not done that, their estimation was that by 2pm that afternoon (September 18th), $5.5 trillion would have been drawn out of the money market system of the United States, [which] would have collapsed the entire economy of the United States, and within 24 hours the world economy would have collapsed."

Further details of these meetings have been provided by Senator James Inhofe, who recounted that Paulson had warned of martial law and civil unrest if the TARP bill failed.

Curiously, in his biographical recount, Paulson makes no mention of those warnings of martial law and civil unrest. But it was the threat of this dire consequence that reportedly played a huge part in Congress’ rash passing of the TARP approval.

The official record of the events of September 18th, 2008 comes from a research report issued by the Joint Economic Committee. The reports states, "On Thursday September 18, 2008, institutional money managers sought to redeem another $500 billion, but Secretary Paulson intervened directly with these managers to dissuade them from demanding redemptions. Nevertheless, investors still redeemed another $105 billion. If the federal government were not to act decisively to check this incipient panic, the results for the entire U.S. economy would be disastrous."

Between the official record and the statements by members of Congress and the Senate, we can piece together that lawmakers were threatened that an almost system-wide collapse of the world financial system was potentially hours away if they failed to act immediately by implementing the recommendations thrust in front of them.

The second fateful date of note was October 7, 2008, when the UK almost collapsed.

Bank of England Governor, Mervyn King, describes the situation: "Two of our major banks which had had difficulty in obtaining funding could raise money only for one week then only for one day, and then on that Monday and Tuesday it was not possible even for those two banks really to be confident they could get to the end of the day."

This was the justification given for the Bank of England to provide secret loans of £61.6 billion to The Royal Bank of Scotland and HBOS to maintain solvency.

Amazingly, news of these loans was never revealed until November 24, 2009; more than one year later.

Recalling that fateful day, David Soanes, Managing Director of UBS Bank, and part of the group assembled to assist with the UK government’s crisis response, stated, "We only really knew by probably about seven o’clock at night (October 7, 2008), that we, that everyone was going to get through to the next day."

These revelations raise new questions about the true scope of bailouts undertaken by the major governments at the time.

Lord Myners, the UK Financial Services Secretary, alluded to similar covert banking operations conducted by the European Central Bank and the US Federal Reserve. We have no idea what he is referring to, but we would certainly be interested to learn more.

This type of activity by the leaders of our financial system certainly helps to explain why those two dates are not more ingrained in our collective memory – strong efforts were obviously made to hide their severity.

What happened in September and October 2008 had previously been considered completely impossible and totally unthinkable.

But... it happened.

Moving forward, the first thing you have to come to grips with is that you must never forget that the ‘unthinkable’ can happen again. Until now we have always been told that the lessons of 1929 and the Great Depression had resulted in changes to the financial system so that NEVER AGAIN could the financial system come close to totally collapsing.

Yet... a complete banking collapse almost did happened. And as unpleasant and incomprehensive as it is, it must be remembered that we almost went there.

So where does this leave us for the decade ahead?

Regardless of whether you agree with the rational of 'imminent demise' used to coerce lawmakers into action in September & October 2008; the reality is that the emergency measures undertaken have left us in tremendously bad fiscal shape.

Our governments responded by liquefying the system beyond any rational explanation. The monetary base has been more than doubled since the collapse of Lehman Brothers.

The debt obligations of the financial system have been passed onto the governments of the Western World, including the government of Canada.

Tomorrow we will examine what that means.

To read the next part, click here.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

Déjà Voodoo Economics, all Over Again. Anyone?... Anyone?....

It's funny. My posts on the sovereign debt crisis and gold have triggered a wave of emails on the economy, interest rates and real estate.

I enjoy reading the email. And I enjoy how my posts trigger some very passionate opinions. I simply don't have the time to answer all the emails, but rest assured... each and every one is read.

I see that there is a need to try and pull together some of my though lines and connect the dots on why I believe they are relevant. So this week I am going to try and do that. I hope you will find this week's posts worthwhile.

Last week Eric Sprott & David Franklin of Sprott Asset Management wrote an excellent article in their ‘Markets at a Glance’ newsletter. I am going to borrow from it to write several of this week’s posts. If you would like to see their actual newsletter click here.

The crisis of 2008 is over?

I have talked numerous times about how many of us really don’t understand the depth and breadth of the financial earthquake that struck the western world in 2008.

Many believe the worst has past.

I maintain that – far from being over – we are plunging headlong into the worst phase of the crisis. Rather than mitigating the fallout, our government has simply compounded the problem and is intensifying the looming repercussions.

You need to understand what happened, appreciate what is developing, and then make your own decisions on the validity of the danger we face.

Then you have to make your own decisions on how best to prepare for what is coming.

The genesis of our current situation

The seeds of the financial mess we are currently experiencing began in the mid-to-late nineties.

As we approached the year 2000, a widespread belief developed that new technology would rewrite economic rules. The euphoric years between 1995 and 2000 became known at the dot-com era. And that euphoria blew into a massive bubble on the technology-heavy NASDAQ Index.

Watching those developments caused Alan Greenspan to first utter his now famous “irrational exuberance” warning in December 1996.

Despite recognizing what was going on, it wasn’t until mid-1999 that the U.S. Federal Reserve actually acted. The Fed increased interest rates in an attempt to quell the overheated stock market. Six times between June 1999 and January 2000 interest rates were raised in an attempt to cool the overheated economy.

On March 10, 2000, the dot-com euphoria burst when the NASDAQ peaked at 5,132 (more than double its value from only a year before). The NASDAQ bubble was born out of over-enthusiasm for the prospects of new technology and the Federal Reserve correctly tried to cool the bubble down, however feebly, in the years before its peak.

And when it burst, the economy should have gone through a recessionary period to consolidate and restructure.

But the NASDAQ collapse compelled Alan Greenspan and the Federal Reserve to embark on the largest rate cuts in US history in an effort to soften the impact of what should have been a difficult recession.

In hindsight we now understand that this was a massive mistake.

Our collective inability to face the consequential economic pain of the dot-com market crash ultimately set the stage for the second bubble of the decade, this time in housing.

By setting out to ‘rescue’ the economy, the Federal Reserve lowered interest rates thirteen times between January 3, 2001 and June 25, 2003.

This ‘economic cushion’ allowed for increasingly easy access to credit on a worldwide scale. And it wasn’t long before the second bubble began to develop.

Call it the law of unintended consequences, but in trying to help the economy, Greenspan unleashed a sequence of events that set the stage for the 2008 financial crisis.

People accessed that easy credit to purchase real estate in euphoric waves. It was as if the basic economic rules were trying to be re-written once again, only this time as they pertained to real estate.

Buying a home was transformed from serving as a place to live... to one where a home became an ‘investment’.

Lower and lower interest rates pushed real estate values higher and higher. Home prices rose at an annualized rate of more than 11% from 2000 to the peak on July 31, 2006 - more than doubling in that time period.

Real Estate became an irrational path to wealth and the warning signs were everywhere. The Economist magazine noticed, stating on June 16, 2005, that "the worldwide rise in house prices is the biggest bubble in history."

Servicing the housing boom propelled the financial sector into the US economy’s central economic driver, generating up to 41% of all corporate profits and making it the fastest growing sector of the economy.

In July 2005, Greenspan described certain real estate markets as "frothy" and recommended that the Federal Reserve rein in lending standards.

It was never done.

Again, in hindsight it’s very safe to argue that the Fed probably shouldn’t have lowered rates thirteen times between January 3, 2001 and June 25, 2003. It proved to be an extremely damaging policy.

Artificially low rates created a lending mania of enormous proportions which dragged consumers along for a debt-fueled buying orgy. It triggered a massive Ponzi scheme sustained by overleverage as the financial sector piled new mortgage financing schemes one atop one another

What happened next was more than just a market failure. It was a systemic meltdown. But it was a meltdown that happened so fast that it seems to have failed to burn into our collective memory.

Everyone remembers that we went into a severe recession in late 2008, but do they know the details of what actually transpired?

Tomorrow we will discuss the collapse of 2008.

Then, later this week, we will discuss how the stage is being set for a Canadian collapse of historic and massive proportions.

To read the next part, click here.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.