Failure to Reflate

The Coming Credit Crunch

by MIKE WHITNEY

 

 

For the second time in three years, the banking system has collapsed, which means that the banks are no longer able to fund themselves through the normal means, the wholesale markets. This same thing happened in July 2007 when two Bear Stearns hedge funds defaulted and trillions of dollars of mortgage-backed securities–which US banks had been holding–began to sharply decline in value. In a matter of months, most of America’s big-name banks were technically insolvent although the charade continued for a full year before Lehman Brothers blew up and the rot within the system became apparent to everyone. Now the same thing is taking place in Europe.

The banks do not get the bulk of their funding through their regulated activities of taking deposits and issuing loans, but by exchanging assets for short-term loans. Naturally, when doubts arise about the quality of these assets, then trading slows to a crawl and the banks are left high-and-dry. In other words, banking has transformed itself into an unregulated multi-trillion dollar pawn shop that can shut down at a moment’s notice leaving the entire industry dead-in-the-water.

When crisis strikes, alarms go off at the central banks who then ride to the rescue with lavish taxpayer-funded bailouts. We’ve seen this play many times before, the script never changes. The central bank chiefs claim that they are just offering liquidity assistance for “temporarily” impaired assets, but, of course, that’s not true. Two years after the Fed began its purchases of toxic MBS from US banks, all of those same assets are still on the Fed’s balance sheet. The Fed’s has become a “bad bank” where the stinkpile of unmarketable dreck the banks created via financial alchemy is housed. Eventually, the losses will be passed on to the taxpayers.

Imagine if the $350,000 home that you bought at the peak of the bubble in 2005 was suddenly “unsellable” at any price. This is the situation EU banks are in. No one wants to do business with them because there are doubts about their solvency as well as questions about the value of their assets. So, the system has shut down forcing the banks have to depend more and more on funding from the ECB. Of course, it doesn’t work this way for the average working guy. When the value of his house falls or his credit score gets slashed, he just has to suck-it-up and live on less because no one will give him a loan. It’s different for bankers.

EU Banking System: How bad is it?
Last week, the ECB lent 523 banks a total of 489 billion euros for three years at 1 percent. On Wednesday, those same banks parked all of the money they borrowed (except 37 billion euros) back at the ECB in overnight deposits. (That’s 452 euros, a new record) Think about that for a minute. In other words, the system is not just broken; it is completely broken.

There’s no lending,  no exchange of assets for short-term loans,  no credit expansion, no nothing. Zilch. All there is is hoarding and a lot of PR gibberish about “emergency liquidity”, “long-term refinancing”, blah, blah, blah. The average Joe doesn’t want a bunch of excuses; they want the facts. And the fact is, this unregulated, volatile, crisis-prone system has collapsed for a second time in three years which is why the central banks are committing trillions (just look at the ECB’s exploding balance sheet) in public money to bailout speculators who’ve gamed the system. That’s all people want to know.

So what is the ECB trying to achieve by pumping all this money into the banking system?
First of all, ECB chief Mario Draghi is trying to reflate the bubble in the bond market. You see, during the boom years, capital flows into Greece, Portugal, Spain etc, boosted the value of the sovereign debt by many orders of magnitude. The main buyers of these bonds were EU banks, so they are loaded to the gills with this junk-paper. Since Greece started teetering, the value of these bonds has plunged leaving many of these banks in the red.

And the situation is even worse than it sounds, because the banks have borrowed more money than the original value of the bonds themselves. In other words, they have posted this same collateral many times over greatly increasing their leverage and their exposure. It would be like if you or I took our prize racing bike down to the pawn shop and exchanged it for a short-term loan of $3,500. Only–in this case–the pawn shop owner allowed us to hold on to the bike. Then we went to another pawn shop, and a third and a forth; posting the same bike for the same short-term loan over and over again. Pretty soon, the debt is so huge, that any disruption in the flow of business, and the whole Ponzi-debt pyramid comes tumbling down. Presently, the ECB is trying to keep that pyramid in place by inflating the value of the dodgy bonds with injections of 3-year liquidity. These loans will never be repaid.

Now take a look at this from the Wall Street Journal:

“Even after the European Central Bank doled out nearly half a trillion euros of loans to cash-strapped banks last week, fears about potential financial problems are still stalking the sector. One big reason: concerns about collateral.

The only way European banks can now convince anyone—institutional investors, fellow banks or the ECB—to lend them money is if they pledge high-quality assets as collateral.

Now some regulators and bankers are becoming nervous that some lenders’ supplies of such assets, which include European government bonds and investment-grade non-government debt, are running low.

If banks exhaust their stockpiles of assets that are eligible to serve as collateral, they potentially could encounter liquidity problems. That is what happened this fall to Franco-Belgian lender Dexia SA, which ran out of money and required a government bailout.” (“European Bank Worry: Collateral”, Wall Street Journal)

So, the banks don’t have money and they don’t have good collateral. And the reason they don’t have good collateral is because they’ve been posting the same collateral over and over again to increase leverage. So, it’s all a sham; they’re upside down and headed for trouble. Here’s more from the same article:

“In addition to fears that the banks might simply run out of eligible collateral, some bankers and regulators worry that the banks’ growing reliance on “secured lending” will make it harder for the industry to return to its past practice of funding itself by issuing unsecured bonds. That could result in a permanent funding scarcity…..

Since this summer, it has been virtually impossible for banks to issue unsecured bonds, because investors view European banks as risky investments.

In the second half of 2011, European banks issued a total of about $80 billion of senior unsecured bonds, according to data provider Dealogic. That compares to $240 billion in the same period last year and $257 billion in 2009.” (“European Bank Worry: Collateral”, Wall Street Journal)

Financial journalists love to make this stuff sound harder than it really is. Look, this is simple. No one is trading with the banks because everyone knows they’re broke. When the author says that the banks’ “growing reliance on “secured lending” will make it harder for the industry to return to its past practice of funding itself by issuing unsecured bonds”; what he means is that the banks funding-model is kaput, because the bonds the banks own are losing value and no sane person will accept them in exchange for cash-money. So, the banksters are out of luck; they have to take their begging bowl to the ECB for handouts. And that’s where we are right now.

So, what’s the bottom line? What do these new developments (Draghi’s $600B Long-Term Refinancing Operation) tell us about the condition of the EU banking system and the probability of another financial crisis?

That’s the question I asked a friend of mine who works in the credit markets. Here’s what he said:

“Ask yourself one question, what has materially changed relating to solvency issues for banks in Europe in general and solvency issues for European countries in particular?

Nothing.

A credit crunch is unavoidable, and a meltdown is a possibility.”

You can’t sum it up any better than that.

Market crash 'could hit within weeks', warn bankers

A more severe crash than the one triggered by the collapse of Lehman Brothers could be on the way, according to alarm signals in the credit markets.

By Harry Wilson, and Philip Aldrick

24 Aug 2011

 

Insurance on the debt of several major European banks has now hit historic levels, higher even than those recorded during financial crisis caused by the US financial group's implosion nearly three years ago.

Credit default swaps on the bonds of Royal Bank of Scotland, BNP Paribas, Deutsche Bank and Intesa Sanpaolo, among others, flashed warning signals on Wednesday. Credit default swaps (CDS) on RBS were trading at 343.54 basis points, meaning the annual cost to insure £10m of the state-backed lender's bonds against default is now £343,540.

The cost of insuring RBS bonds is now higher than before the taxpayer was forced to step in and rescue the bank in October 2008, and shows the recent dramatic downturn in sentiment among credit investors towards banks.

"The problem is a shortage of liquidity – that is what is causing the problems with the banks. It feels exactly as it felt in 2008," said one senior London-based bank executive.

"I think we are heading for a market shock in September or October that will match anything we have ever seen before," said a senior credit banker at a major European bank.

Despite this, bank shares rebounded on Wednesday, showing the growing disconnect between equity and credit investors. RBS closed up 9pc at 21.87p, while Barclays put on 3pc to 149.6p despite credit default swaps on the bank hitting a 12-month high. This mirrored the US trend, with Bank of America shares up 10pc in late Wall Street trade after a hitting a 12-month low on Tuesday over fears that it might have to raise as much as $200bn (£121bn).

As with the European banks, the rebound in the share price was not reflected in the credit markets, where its CDS reached a 12-month high of 384.42 basis points.

European stock markets joined in the rally. The FTSE closed up 1.5pc at 5,206 on hopes the chance of a global recession had diminished. European shares hit a one-week high, with Germany's DAX closing up 2.7pc and France's CAC 1.8pc higher. The Dow Jones index edged higher on strong durable goods orders data as markets began to accept that the US Federal Reserve is unlikely to signal fresh stimulus at Jackson Hole this Friday.

Even Moody's decision to downgrade Japan's sovereign credit rating by one notch to Aa3 did little to damage global sentiment, although Tokyo's Nikkei closed down just over 1pc.

As stock market nerves settled, gold - which has recorded steady gains recently as investors seek a safe haven - fell 5.3pc to $1,777 in London.

Disastrous Outcomes From an Orchestrated Crisis

Will the Ceiling Fall In?
By PAUL CRAIG ROBERTS

With the world concerned about US financial credibility and the poor outlook for the US economy, now is not the time for the Republicans to grandstand on the public debt. The debt ceiling needed to be quietly raised. Instead, the Republicans started a fire and then threw gasoline on it, creating an inferno that could burn up the US social safety net or the US Treasury’s credit rating and the US dollar’s role as reserve currency or what remains of the separation of powers.

Consequently, world financial markets, currency markets, commodity markets, central banks, and mutual fund money market and bond funds are on pins and needles.

This level of irresponsibility is seldom seen even from American politicians.

Republicans have created a totally unnecessary crisis and turned it into compelling political theater. Will the US default? Will entitlements be slashed? Will Obama seize the power of the purse from Congress in order to save the dollar and the US credit rating? None of these questions needed to arise.

While the world media fixates on the orchestrated debt ceiling crisis, the US government continues to bomb civilians in Afghanistan, Libya, Iraq, Pakistan, Yemen, and Somalia and continues with preparations to do the same thing to Syria and Iran.

The violations of other countries’ sovereignties, the naked aggressions that constitute war crimes, the murder of noncombatants, and the horrible moral and economic expense inflicted by the maximization of the military/security complex’s profits are somehow not a crisis. These are just routine, normal, everyday necessary events. Nothing to notice or to become upset about.

The offshoring of US jobs, GDP, tax base, and consumer demand that has eroded away the US economy and the government’s tax base, thus elevating the deficit, is somehow not a crisis. These are just the imperatives of globalism and the routine maximization of shareholders’ profits and management’s performance bonuses.

The US has become such a ridiculous collection of fools that no real crisis can be recognized. Instead, the country is mesmerized by a fake crisis.

The fake orchestrated crisis can easily turn into a real one. If income support programs are slashed, so will be consumer demand, and the US economy will decline further, widening the budget deficit and national debt.

If the Republicans force the country into default, the dollar will suffer. At the least, import prices will rise and the trade deficit with them. At the worse, the dollar will lose its reserve currency role, and the US will no longer be able to pay its oil bill in its own currency. With its balance of payments deep in the red, it has no foreign currency with which to purchase oil.

If Obama has to seize the power of the purse in order to prevent a new financial crisis from landing on top of the ongoing financial crisis, democracy will take another big hit.

Americans need desperately to ask themselves why they put into political office such utterly irresponsible and incompetent people capable of creating such a totally unnecessary crisis loaded with such disastrous potential outcomes. It would appear that the American population is too insouciant to use the vote with any care.

Little wonder that the president is becoming a Caesar.

The Market: the New Faith

A Death-Breeding Logic
By ERIC TOUSSAINT

Practically all political leaders - whether from the traditional Left or the Right, from the North or the South - have a quasi-religious faith in the market, especially the financial markets. Or rather, they themselves are the high priests of this religion. Every day in every country, anyone with a television or an Internet connection can attend mass and worship the market-god - in the form of stock exchange and financial market reports. The market-god sends his messages through television anchormen and the financial editors of daily newspapers. Today, this happens not only in OECD countries, but in most parts of the planet. Whether you are in Shangai or Dakar, Rio de Janeiro or Timbuktu, you can receive 'market signals'. Everywhere, governments have privatised and created the illusion that the population will be able to participate directly in market rituals (by buying shares) and reap the benefits in accordance with how well one interprets signals sent by the market-god. In actual fact, the small part of the working population that has acquired shares has no say over market tendencies.

In a few centuries, the history books might say that from the 1980s onwards a fetishist cult prospered. The dramatic rise of this cult will perhaps be associated with two heads of state, Margaret Thatcher and Ronald Reagan. It will be noted that, from the start, this cult had the backing of governments and powerful private financial interests. Indeed, for this cult to gain ground within the population, public and private media found it necessary to pay homage to it day in and day out.

The gods of this religion are the financial markets. Its temples are known as Stock Exchanges. Only the high priests and their acolytes can tread their holy ground. The faithful are called upon to commune with their market-god on television, on their computer screen, in the daily papers, on the radio or at the bank. Thanks to television, radio and the Internet even in the most remote parts of the planet, hundreds of millions of people who are deprived of the right to meet their basic needs, are also urged to celebrate the market-god. In the North, in newspapers read by a majority of workers, housewives and unemployed, an 'investment' section is published every day, even though the overwhelming majority of readers do not own a single share. Journalists are paid to help the faithful understand signals sent by the gods.

To heighten the power of the gods in the eyes of the faithful, commentators periodically declare that the gods have sent signals to governments to express their satisfaction or discontent. The Greek government and parliament have at last understood the message sent by the gods and adopted a drastic austerity plan that has the lower classes paying the price. But the gods are dissatisfied with Spain, Portugal, Italy and Ireland. Their governments too will have to contribute their ritual offerings in the guise of strong antisocial measures.

The places where the gods are most likely to forcefully express their moods are Wall Street in New York, the City in London, and the Paris, Frankfurt and Tokyo stock exchanges. To gauge their moods, special indicators have been devised: the Dow Jones in New York, the Nikkei in Tokyo, the CAC40 in France, the Footsie in London, the Dax in Francfort,… To appease the gods, governments must sacrifice the Welfare State to the stock markets. They must also privatise public property.

Why are ordinary market operators given a religious aura? They are neither anonymous nor ethereal. They have names, addresses. They are the people in charge of the 200 biggest TNCs that control the world with the help of the G7, the G20 and institutions such as the IMF, which came back into the limelight thanks to the financial crisis. Next we also have the World Bank and the World Trade Organisation, currently in a rather difficult predicament, but who knows, the gods might favour it again soon. Governments are no strangers to this situation; from Reagan and Thatcher onwards, they relinquished the means they had of controlling financial markets. The situation is now almost reversed: institutional investors (i.e. major banks, pension funds, insurance companies,hedge funds, etc.) received thousands of billions dollars from governments in the form of grants or loans to bail them out after the 2007-8 meltdown. The European Central Bank, the US Federal Reserve, the Bank of England now lend them money on a daily basis at a lower rate than the capital inflation that institutional investors immediately use to speculate against the euro and against public money.

Money can cross borders without a single cent in taxes being levied. More than 3,000 billion dollars race around the planet every day. Less than 2 per cent of this amount is linked to actual trade in goods and services or to productive investments. More than 98 per cent is used for purely speculative operations mainly on currencies, on commodities, and on debt securities.

We have to put a stop to this death-breeding logic. We have to develop a new financial discipline, to expropriate the financial sector and exert social democratic control on all financial matters, to tax all institutional investors (which triggered and then profited from the crisis) heavily, to audit and cancel public debts, to implement a distributive tax reform, to drastically reduce working hours so as to offer more jobs while maintaining wages at their current level... In short, we must launch an anticapitalist project.

Junk Bond Avalanche Looms for Credit Markets

Junk Bond Avalanche Looms for Credit Markets
03-16-2010

Source: NY Times

When the Mayans envisioned the world coming to an end in 2012 — at least in the Hollywood telling — they didn’t count junk bonds among the perils that would lead to worldwide disaster.

Maybe they should have, because 2012 also is the beginning of a three-year period in which more than $700 billion in risky, high-yield corporate debt begins to come due, an extraordinary surge that some analysts fear could overload the debt markets.

With huge bills about to hit corporations and the federal government around the same time, the worry is that some companies will have trouble getting new loans, spurring defaults and a wave of bankruptcies.

The United States government alone will need to borrow nearly $2 trillion in 2012, to bridge the projected budget deficit for that year and to refinance existing debt.

Indeed, worries about the growth of national, or sovereign, debt prompted Moody’s Investors Service to warn on Monday that the United States and other Western nations were moving “substantially” closer to losing their top-notch Aaa credit ratings.

Sovereign debt aside, the approaching scramble for corporate financing could strain the broader economy as jobs are cut, consumer spending is scaled back and credit is tightened for both consumers and businesses.

The apocalyptic talk is not limited to perpetual bears and the rest of the doom-and-gloom crowd.

Even Moody’s, which is known for its sober public statements, is sounding the alarm.

“An avalanche is brewing in 2012 and beyond if companies don’t get out in front of this,” said Kevin Cassidy, a senior credit officer at Moody’s.

Private equity firms and many nonfinancial companies were able to borrow on easy terms until the credit crisis hit in 2007, but not until 2012 does the long-delayed reckoning begin for a series of leveraged buyouts and other deals that preceded the crisis.

That is because the record number of bonds and loans that were issued to finance those transactions typically come due in five to seven years, said Diane Vazza, head of global fixed-income research at Standard & Poor’s.

In addition, she said, many companies whose debt matured in 2009 and 2010 have been able to extend their loans, but the extra breathing room is only adding to the bill for 2012 and after.

The result is a potential financial doomsday, or what bond analysts call a maturity wall. From $21 billion due this year, junk bonds are set to mature at a rate of $155 billion in 2012, $212 billion in 2013 and $338 billion in 2014.

The credit markets have gradually returned to normal since the financial crisis, particularly in recent months, making more loans available to companies and signaling confidence in the pace of economic recovery. But the issue is whether they can absorb the coming surge in demand for credit.

As was the case with the collapse of the subprime mortgage market three years ago, derivatives played a big role in the explosion of risky corporate debt. In this case the culprit was a financial instrument called a collateralized loan obligation, which helped issuers repackage corporate loans much as subprime mortgages were sliced, diced and then resold to other investors. That made many more risky loans available.

“The question is, ‘Should these deals have ever been financed in the first place?’ ” asked Anders J. Maxwell, a corporate restructuring specialist at Peter J. Solomon Company in New York.

The period from 2012 to 2014 represents payback time for a Who’s Who of private equity firms and the now highly leveraged companies they helped buy in the precrisis boom years.

The biggest include the hospital owner HCA, which was taken private in 2006 by a group led by Bain Capital and Kohlberg Kravis & Roberts for $33 billion, and has $13.3 billion in debt payments coming due between 2012 and 2014. Another buyout led by Kohlberg Kravis, for the giant Texas utility TXU, has $20.9 billion that needs to be refinanced in the same period.

Realogy, which owns real estate franchises like Century 21 and Coldwell Banker, was taken private by Apollo in the spring of 2007 just as the housing market was beginning to unravel and as the first tremors of the subprime crisis were being felt.

Realogy was saddled with $8 to $9 of debt for every $1 in earnings, well above the “$5 to $6 level that is manageable for a company in a highly cyclical industry,” according to Emile Courtney, a credit analyst with Standard & Poor’s.

Realogy has survived — barely. “The company’s cash flow is still below what’s needed to cover the interest on its debt,” Mr. Courtney said.

Realogy said it ended 2009 with a substantial cushion on its financial covenants and over $200 million of available cash on its balance sheet. “The company generated over $340 million of net cash provided by operating activities in 2009 after paying interest on its debt,” the company said.

Not everyone is convinced that 2012 will spell catastrophe for the junk bond market, however.

Optimists like Martin Fridson, a veteran high-yield strategist, note that investors seeking high yields snapped up speculative-grade bonds last year and early this year, and he suggests that continued demand will allow companies to refinance before their loans come due.

“The companies have nearly two years to push out the 2012 maturity wall,” he said. “Of course, the ability to refinance will depend upon the state of the economy.”

That is still a wild card, but even if the economy improves, companies with a lot of debt will be competing with a raft of better-rated borrowers that are expected to seek buyers of their debt at around the same time.

Chief among those is the best-rated borrower of all: the United States government. The Treasury Department estimates that the federal budget deficit in 2012 will total $974 billion, down from this year’s $1.8 trillion, but still huge by historical standards.

Most critics of deficit spending have focused on the budget gap alone, but Washington will actually have to borrow $1.8 trillion in 2012, because $859 billion in old bonds will come due and have to be refinanced in addition to the deficit. By 2013 and 2014, $1.4 trillion will have to be raised annually.

In the late 1990s, the federal government ran a surplus and actually paid down a small portion of the national debt. But with the huge deficits of the last few years, the national debt has grown to more than $12 trillion.

Next in line are companies with investment-grade credit ratings. They must refinance $1.2 trillion in loans between 2012 and 2014, including $526 billion in 2012. Finally, there is the looming rollover of commercial mortgage-backed securities, which will double in the next three years, hitting $59.7 billion in 2012.

Even if most of the debt does get refinanced, companies may have to pay more, if heavy government borrowing causes rates for all borrowers to rise.

“These are huge numbers,” said Tom Atteberry, who manages $5.6 billion in bonds for First Pacific Advisors, and is particularly alarmed by Washington’s borrowing. “Other players will get crowded out or have to pay significantly more, because the government is borrowing so much.”