Paulson's Blunders as Debt Securitization Market Remains Frozen
By: Mike_Whitney
Nov 15, 2008
Henry Paulson's time at Treasury has been one pratfall after another. Even so, on Tuesday he managed to outdo himself. Paulson held a "surprise" press conference where he announced that the $700 billion Troubled Asset Relief Program (TARP) wouldn't be used to buy troubled assets after all. Instead, the money will used to bail out insurance giant AIG, provide extra capital for the banks to hoard, and now (this is new part) give money to "nonbank financial institutions, like insurers and specialty-finance companies" so they can lend to credit-worthy consumers. (Isn't that why we gave money to the banks?)
Paulson's announcement was like tossing a
hand-grenade in a San-i-can; it blew the stock market to Kingdom
come. Just minutes after the opening bell on the New York Stock
Exchange (NYSE) stocks plummeted to new lows ending the session in a
400 point death-spiral. Wall Street doesn't like uncertainty and
Paulson's sudden about-face sent jittery investors running for
cover. The message to investors is clear, the government doesn't
have the foggiest idea of what it's doing and is just grasping at
straws.
But
Paulson's no fool; he knew exactly what the reaction would be on
Wall Street. He simply decided that blowing up the equities market
was worth the price of reviving "securitization"--the transformation
of loans into securities. You see, securitization is Wall Street's
Golden Goose. It's the foundation block upon which structured
finance and all its complex credit-enhancing derivatives rests. Keep
in mind, that all these exotic, financially-engineered products--the
CDOs, MBS, and CDS--were all created with one goal in mind;
to maximize leverage with minimum capital so that profits can be
skimmed off the top. That's how Paulson managed to walk away from
Goldman Sachs with hundreds of millions of dollars in his pockets.
It's a racket.
There's a myth that credit is contracting because the banks won't
lend. But, in truth, total bank credit expanded by $575 billion over
the past 10 weeks. The real problem is that the securitzation market
remains frozen.
So now Paulson wants to breathe new life into securitization by
providing liquidity for nonbank financial institutions who get their
money from the wholesale market. Of course, no one really knows how
this will work since these operations are completely unregulated by
the federal government. No worries; the charade will persist behind
the dodgy claim that "it's needed to get credit to the consumer".
Baloney. What the consumer needs job security and a pay-raise, not
more debt. This is just more Paulson flim-flam.
It was clear that the Treasury Secretary was concocting a new
swindle a couple weeks ago when Fed chief Bernanke defended "securitzation
in a speech where he said:
"The ability of financial intermediaries to
sell the mortgages they originate into the broader capital market by
means of the securitization process serves two important purposes:
First, it provides originators much wider sources of funding than
they could obtain through conventional sources, such as retail
deposits; second, it substantially reduces the originator's exposure
to interest rate, credit, prepayment, and other risks associated
with holding mortgages to maturity, thereby reducing the overall
costs of providing mortgage credit."
Nonsense. What it really does is create the optimal environment
for speculative leveraging, debt-pyramiding and massive
profit-taking. But, that's beside the point. The real issue is that
securitization is dead already because Paulson and his ilk poisoned
the well by adding subprime garbage and Alt As to the mix. Now
investors are steering clear of any securities that bundle debt.
It's a confidence issue.
According to the Wall Street Journal:
"Banks and other finance companies making loans for autos, credit
cards and college tuition are having virtually no success in selling
those loans to other investors, a potent sign of just how tight
credit markets remain.
The market for selling such loans — by packaging, or securitizing,
them into bonds — had just one $500 million deal for all of October,
according to Barclays Capital. That compares with $50.7 billion
worth of deals made one year earlier, according to market-research
firm Dealogic. The overall market for so-called asset-backed
securitization is estimated at $2.5 trillion. (Bond Woes Choke off
some Credit to Consumers, Wall Street Journal, Robin Sidel)
$500 million is just 1 percent of $50 billion! Securitization will
be dead for a decade or so; it was destroyed by lax lending
standards and easy credit. Paulson and his fellows will have to find
a new way to fleece gulible investors.
The TARP is most expensive boondoggle in history. No one even knows
what the banks are doing with the money. There's neither
accountability nor transparency. As a result, investor confidence
has deteriorated and stocks have continued to fall. No one trusts
Paulson to do the right thing anymore; it's that simple.
The Treasury's new Financial Stability Oversight Board has met four
times, but they still can't say how the banks are using the money.
It's a joke. Congress has been missing in action, too. They promised
to create their own oversight board, but five weeks have passed and
still nothing has happened. Apparently, the idea throwing $700
billion down rathole isn't enough to prod Ms. Pelosi and her
congressional cohorts into action. All that really matters to them
is getting reelected and nuzzling ever-closer to the public trough.
The TARP fiasco is not taking place in a vacuum either; the country
is at the beginning of the deepest consumer-led recession in the
last half century. Retail spending and automobile sales have been
following the same grim flightpath as housing, while unemployment is
at a 7 year high soaring to nearly 4 million. Household debt is at
record levels of $14 trillion. The job market is steadily weakening
while the consumer is more vulnerable than ever. Meanwhile, Paulson
has dragged his feet on rewriting mortgages to slow foreclosures,
stalled on providing another stimulus package, and diverted all the
money from the $700 billion bailout to his friends in the financial
industry. Not one dime has gone to a working man or woman. Paulson
continues to play games while Rome burns even though, according to
his colleague, former G-Sax chairman John Whitehead, the current
downturn will be worse than the Great Depression.
According to Reuters: "The economy faces a
slump deeper than the Great Depression and a growing deficit
threatens the credit of the United States itself, former Goldman
Sachs chairman John Whitehead ...
"I think it would be worse than the depression," Whitehead said.
"We're talking about reducing the credit of the United States of
America, which is the backbone of the economic system. ... I see
nothing but large increases in the deficit, all of which are serving
to decrease the credit standing of America. ... I just want to get
people thinking about this, and to realize this is a road to
disaster. I've always been a positive person and optimistic, but I
don't see a solution here."
There is no solution. The first thing to realize is that it is not a
matter of "fixing" the economy. The economy is fixing itself by
purging the unsustainable debt from the system. That's how markets
work. Greenspan's low interest rates created a subsidy for debt
which--along with the alphabet soup of leveraged derivatives--buoyed
the economy along on the biggest wave of speculative financing the
world has ever seen. The distortions that were caused by the
unprecedented credit expansion stimulated artificial demand that
created the appearance of growth and prosperity but, in truth, was
nothing more than an equity bubble. Now the bubble has popped and
the financial system is returning to the mean.
That means that credit will probably contract
by 30 to 40 percent putting us on the path to another Great
Depression. Unless the government takes preventative action to get
money into the hands of consumers and restore confidence, the nation
will face (what David Brooks called) "grueling scarcity" and
widespread panic. That's probably why all the voting machines and
exit polls finally matched up with the election results in the 2008
presidential balloting for the first time in 8 years; because the
ruling elites know that they need a popular executive to put in
front of the cameras when they try to calm the crowds and keep the
country from disintegrating into anarchy. It also explains the
nervous smiles on the faces of the money-lenders and graybeards
assembled on the stage behind Obama at his first press conference.
The American establishment is placing all its hopes for economic
survival on the narrow shoulders of their newest posterboy, Barak
Hussein Obama.
There's more pain to come, but the suffering can be mitigated by
sound decision-making and Keynesian policies. That means public work
programs, bankruptcy reform, and extensions on unemployment. Nobel
prize winner Paul Krugman recommends a stimulus package of $600
billion. That's a good start, but it will take much more than that.
And foreign investors will have to be confident in our choices or
the sale of Treasurys will slip and the US will face a funding
crisis. The Fed's lending facilities have already loaned $2 trillion
while the Treasury's bailout is $700 billion. By the end of 2010,
fiscal deficits will be nearly $2 tillion and the total cost to the
US taxpayer will be at least $5 trillion. That means rising interest
rates, flagging growth and hard times ahead.
The present financial crisis is a self-inflicted wound. It started
at the Federal Reserve with their cynical neoliberal monetary
policies. Any solution, that does not involve the dismantling of the
Fed, is unacceptable.
By Mike Whitney
Email: fergiewhitney@msn.com
Mike is a well respected freelance writer living in Washington state, interested in politics and economics from a libertarian perspective.