There are smart ways to raise money and regulate the market, but Wall Street is working to kill any meaningful financial reform
By Dean Baker
July 01, 2009 "The Guardian" -- Last month, when the US Congress failed to pass a bankruptcy reform measure that would have allowed home mortgages to be modified in bankruptcy, senator Dick Durbin succinctly commented: "The banks own the place." That seems pretty clear.
After all, it was the banks' greed that fed the housing bubble with loony loans that were guaranteed to go bad. Of course the finance guys also made a fortune guaranteeing the loans that were guaranteed to go bad (ie AIG), and when everything went bust, the taxpayers got handed the bill. The cost of the bailout will certainly be in the hundreds of billions, if not more than $1tn when it is all over.
More importantly, we are looking at the most severe economic downturn since the Great Depression. The cumulative lost output over the years 2008-2012 will almost certainly exceed $5tn. That comes to more than $60,000 for an average family of four. This is the price that we are paying for the bankers' greed, coupled with incredible incompetence and/or corruption from our regulators.
Under these circumstances, it would be reasonable to think that the bankers would be keeping a low profile for a while. That's not the way it works in Washington. The banks are aggressively pushing their case in Congress and Obama administration. Not only are we not going to see bankruptcy reform, but any financial reform package that gets through Congress will probably contain enough loopholes that it will be almost useless.
In this political environment, the poor might get empathy, but Wall Street gets money, and lots of it. Even when the issue is global warming Wall Street has its hand out. The fees on trading carbon permits could run into the hundreds of billions of dollars in coming decades. A simple carbon tax would have been far more efficient, but efficiency is not the most important value when it comes to making Wall Street richer.
This is why it was so encouraging to see congressman Peter DeFazio's proposal to tax trades in oil options and futures. DeFazio proposed a tax of 0.02% on trades in oil futures and options as a way to make up a shortfall in the federal government's highway trust fund. This tax could raise billions of dollars each year in revenue and make speculation in the oil market a more dangerous affair.
The logic is very simple. For someone using these markets to hedge, the tax will be inconsequential. For example, a farmer that hedges a $400,000 wheat crop will pay $80 when selling a future. Similarly, airlines that hedge by buying oil futures will barely notice the higher cost. In fact, because trading costs have fallen so much in recent decades, a tax at this level would just be raising costs back to their levels of two decades ago, a point at which there was already a very vibrant futures and options market.
However, even a modest tax will make life much more difficult for speculators. Many of them expect to make quick short-term gains, often buying and selling the same day. For these traders, an increase in transactions costs of 0.02% would be a burden.
Of course, a modest tax will not drive the speculators out of the market altogether, it is just likely to reduce the volume of speculation. For this reason, even a modest tax can still raise an enormous amount of money in a market where tens of trillions of dollars of derivatives changes hands each year.
This tax can best be thought of as a tax on gambling. Gambling is heavily taxed in every state that allows it. DeFazio's bill is effectively a tax on gambling in the oil markets. It will not stop it, but it would discourage it, and in the process raise a huge amount of money that could go to productive purposes.
The bill faces an enormous uphill struggle in Congress. As Durbin said, the banks own the place, and they are not going to just step aside and let Congress impose a tax on such a lucrative business. But, it is important that people know about the DeFazio bill. First, DeFazio deserves a place on the honour roll for standing up to Wall Street.
Also, it is important for the public to know that there is a relatively low-cost way to make up the shortfall in the highway trust fund. When Congress raises some other tax and/or cuts a useful programme, people should know that there was a better alternative. It just didn't happen because, as we know, the banks own the place.
Showing posts with label Great Depression. Show all posts
Showing posts with label Great Depression. Show all posts
Saturday, July 4, 2009
Tuesday, March 10, 2009
Debt Relief and Regulation
By Mike Whitney
"We've explained the difference between a recession and a depression before. But we'll do it again. A recession is a pause in an otherwise healthy, growing economy. A depression is when the economy drops dead." Bill Bonner, The Daily Reckoning
March 09, 2009 "Information Clearing House" -- There's good news and bad news. The good news is that Obama's economics team understands the fundamental problem with the banks and knows what needs to be done to fix it. The bad news is that Bernanke, Summers and Geithner all have close ties to the big banks and refuse to do what's necessary. Instead, they keep propping up failing institutions with capital injections while concocting elaborate strategies for purchasing the banks bad assets through backdoor transactions. It's all very opaque, despite the cheery public relations monikers they slap on their various "rescue" plans. This charade has gone on for more than a month while unemployment has continued to soar, the stock market has continued to plunge, and the country has slipped deeper into economic quicksand.
Paul Krugman summed up the administration's response in Friday's column, "The Biig Dither":
"There’s a growing sense of frustration, even panic, over Mr. Obama’s failure to match his words with deeds. The reality is that when it comes to dealing with the banks, the Obama administration is dithering. Policy is stuck in a holding pattern....
Why do officials keep offering plans that nobody else finds credible? Because somehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets ... are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away. ...
What’s more, officials seem to believe that getting toxic waste properly priced would cure the ills of all our major financial institutions.(Paul Krugman, The Big Dither, New York Times)
Krugman is right about the "dithering" but wrong about the toxic waste. Geithner and Bernanke know exactly what these assets are worth--- just pennies on the dollar. That's why Geithner has avoided taking $5 or $10 billion of these mortgage-backed securities (MBS) and putting them up for public auction. That would be the reasonable thing to do and it would remove any doubt about their true value. But the Treasury Secretary won't do that because it would just draw attention to the fact that the banking system is insolvent; the vaults are full of nothing but garbage loans that are defaulting at a record pace. Instead, Geithner has cooked up a plan for a "public-private partnership" which will provide up to $1 trillion in funding for private equity and hedge funds to purchase toxic assets from the banks. The Treasury will offer low interest "non recourse" loans (with explicit government guarantees against any potential loss) to qualified investors. If the hedge funds or private equity firms don't turn a profit in three years, they simply return the assets to the Treasury and get their money back. In essence, Geithner's plan provides a lavish subsidy to private industry on a totally risk free investment. It's a sweetheart deal.
At the same time, the plan achieves Geithner's two main objectives; it gives the banks the chance to scrub their balance sheets of junk mortgages and it also allows them to keep the present management-structure in place. The $1 trillion taxpayer giveaway to the hedge funds is just another juicy bone tossed to Geithner's real constituents-- Wall Street speculators.
Unfortunately, markets don't like uncertainty, which is why Geithner's circuitous plan has put traders in a frenzy. Wall Street has gone from scratching its head in bewilderment, to a stampede for the exits. In the last month alone, the stock market has plummeted a whopping 18 percent, indicating ebbing confidence in the political leadership. Geithner is now seen as another glorified bank lobbyist like his predecessor, Paulson, who is in way over his head. His lack of clarity has only added to the widespread sense of malaise. Markets require transparency and details, not obfuscation, gibberish and Fed-speak. This is how Baseline Scenario blogger Simon Johnson summed it up:
"Confusion helps the powerful... When there are complicated government bailout schemes, multiple exchange rates, or high inflation, it is very hard to keep track of market prices and to protect the value of firms. The result, if taken to an extreme, is looting: the collapse of banks, industrial firms, and other entities because the insiders take the money (or other valuables) and run.
This is the prospect now faced by the United States.
Treasury has made it clear that they will proceed with a “mix-and-match” strategy, as advertised....The course of policy is set. For at least the next 18 months, we know what to expect on the banking front. Now Treasury is committed, the leadership in this area will not deviate from a pro-insider policy for large banks; they are not interested in alternative approaches (I’ve asked). The result will be further destruction of the private credit system and more recourse to relatively nontransparent actions by the Federal Reserve, with all the risks that entails.
"The road to economic hell is paved with good intentions and bad banks."(Simon Johnson Baseline Scenario)
This is unusually harsh criticism from a former head economist at the IMF, but Johnson's analysis is dead-on. Geithner is putting the interests of the banks before those of the country. The "public private partnership" is just a convoluted way of avoiding the heavy-lifting of rolling up the banks, wiping out shareholders, separating the bad assets, and replacing management. The same is true of Bernanke's Term Asset-Backed Securities Loan Facility (TALF) which is another futile attempt to restart Wall Street's failed credit-generating mechanism, securitization. It was securitization (which is the conversion of pools of mortgages into securities) which got us into this mess to begin with. It doesn't do any good to restore an inherently crisis-prone system that only works properly when the market is going up. There are more efficient ways to recapitalize the banks than the PPP, just as there are better ways to promote consumer spending than the TALF. Treasury should be looking into debt relief, jobs programs and higher wages, instead of barreling blindly down the same dead end. There are solutions that do not involve artificially low interest rates, government subsidies for toxic waste or lavish handouts to hedge funds. They simply require a commitment to rebuild the economy on sound principles of hard work, productivity and fair distribution of the the profits.
Even industry cheerleaders, like the Wall Street Journal, are skeptical of Bernanke's TALF and have denounced it as just another boondoggle.
Wall Street Journal: “If you missed the first hedge-fund boom, now may be the time to put up your shingle. Looking at the terms of the Federal Reserve’s new Term Asset-Backed Securities Loan Facility, investors using it should be able to generate hefty returns with little risk. The TALF effectively turns the Fed into a generous prime brokerage.”
Who needs a free market when Obama's Politburo is more than willing to prop up private industry with hundreds of billions of tax dollars?
There is another part of Geithner's plan that is even more troubling, that is, after the banks sell their dodgy assets to the hedge funds, what will they do with the money? Consumers are retrenching, so the pool of creditworthy customers will remain small. And businesses are trying to work off existing inventory, so they won't be borrowing to increase investment or retool anytime soon. If the opportunities for lending dry up, the banks will be forced to seek unconventional means for generating profits. My guess is the banks will put a large portion of their money into hedge funds for commodities speculation, which will push the price of oil, natural gas and other raw materials into the stratosphere just like they did last year when oil shot up to $147 bbl. The banks really have no choice; 65 percent of their business was securitized investments. That door has been slammed shut for good.
"TOO BIG TO FAIL"?
The Financial Times economics editor Martin Wolf warned in Friday's column of the dangers of our present course. He said:
"If large institutions are too big and interconnected to fail... then talk of maintaining them as “commercial” operations... is a sick joke. Such banks are not commercial operations; they are expensive wards of the state and must be treated as such.
The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. (Martin Wolf, Big risks for the insurer of last resort, Financial Times)
Citigroup is now officially a "ward of the state" although CEO Pandit and his scurvy band of pirates are still allowed to collect their paychecks and hang out by the water cooler. Citi's survival depends on the reluctant generosity of the US taxpayer who is now its biggest shareholder. The mega-bank has slumped from $58 per share to $1 per share in less than 2 years. It's now more expensive to buy a grande latte at Starbucks than it is to buy three shares of Citi...and, at least with the Starbucks, the buyer gets a buzz on. There's no upside to the Citi deal. It's a dead-loss. The real question is, how long will Geithner let this joke continue before he does his job?
Wolf is correct to draw attention to the myth of "too big to fail". In fact, the Kansas Federal Reserve President, Thomas Hoenig made the same point in a PDF released this week:
"We have been slow to face up to the fundamental problems in our financial system and reluctant to take decisive action with respect to failing institutions. ... We have been quick to provide liquidity and public capital, but we have not defined a consistent plan and not addressed the basic shortcomings and, in some cases, the insolvent position of these institutions.
We understandably would prefer not to "nationalize" these businesses, but in reacting as we are, we nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis." (Too Big has Failed, thanks to Calculated Risk)
Hoenig and Wolf are smart enough to know that the problem is not as simple as it sounds. They know that the largest financial institutions are lashed together in a net of complex counterparty contracts--mainly credit default swaps (CDS)--which run into tens of trillions of dollars, and, that if one player is allowed to default, it could pull all of the others down the elevator shaft along with it. The problem could be resolved with proper regulation which would force all CDS onto a regulated exchange so that government watchdogs could make sure that they are sufficiently capitalized to pay off whatever claims are levied against them. But, so far, no one in Congress has taken the initiative to propose the necessary regulation. Thus, the taxpayer continues to pay off hundreds of billions of dollars of insurance claims against AIG, which was so grossly under-capitalized, it couldn't meet its own obligations. The AIG fiasco provides a window into the real motivation behind financial engineering and the alphabet-soup of complex debt-instruments. (CDOs, MBSs, CDS) Wall Street knew that the fastest way to fatten the bottom line was to circumvent minimum capital requirements and expand leverage to unsustainable levels. In other words, a system of debt-fueled capitalism with only specks of capital. It worked beautifully, until it didn't.
Nobel prize-winning economist, Myron Scholes, who helped invent a model for pricing options, added his voice to the growing chorus of angry reformers who think the CDS market should be scrapped altogether. According to Bloomberg News: Scholes said "regulators need to ‘blow up or burn’ over-the-counter derivative trading markets to help solve the financial crisis. The markets have stopped functioning and are failing to provide pricing signals... The “solution is really to blow up or burn the OTC market, the CDSs and swaps and structured products, and let us start over.” (Bloomberg)
Treasury and the Fed have taken the position that they will not fix the system until they are forced at gunpoint. This is a prescription for disaster, not just because of growing public frustration or the free-falling stock markets, but because the banks are just the tip of the iceberg. The other non bank financial institutions are brimming with mortgage-backed sludge that will require emergency treatment, too. MarketWatch gives us a glimpse of the magnitude of the problem in last week's article "Banks fall out of bed, Citi shares under a buck":
"Market strategist Ed Yardeni's latest research shows that.....80.6%, or $7.4 trillion, of the assets held by the S&P financials companies were Level 2," he said in a research report. Level 2 assets are so-called mark-to-model, which are carried at a value based on assumptions, not true market prices."
What does "Level 2 assets" mean? It means that the financial giants are short on liquid assets--like cash or US Treasurys--and loaded with sketchy mortgage-backed paper to which they have arbitrarily assigned a value that no one in their right mind would ever pay. The entire US financial system, including the pension funds and insurance companies, is one humongous debt-bloated time bomb that is set to blow at any minute.
Surprisingly, Bernanke thinks he can simply wave his wand and restart the moribund credit markets. That's what the TALF is all about. The problem is that even if the Fed buys all of the AAA securities held by the respective financial institutions, (most of them are non banks) that still only accounts for 20 percent of the bad paper on the books. Here's what Tyler Durden said on Zero Hedge web site:
"Unfortunately for Geithner, who apparently did not read too deeply into the data, the bulk of the $1 trillion decline in securitizations came from home equity lending and non agency RMBS (Residential Mortgage Backed Securities), which reflect the "non-conforming" mortgage market, i.e. the subprime, alt-A and jumbo origination, loans which are the cause for the credit crisis, and which are rated far below the relevant AAA level. The truly unmet market, which the Treasury is addressing is at best 20% of the revised total amount." (Tyler Durden, Could TALF be the biggest disappointment yet?, Zero Hedge)
That leaves Geithner and Bernanke with few good choices. Either they expand TALF to include crappy AA (and lower) graded securities--putting the taxpayer at even greater risk--or they devise some totally new lending facility that will bypass the financial institutions altogether and issue credit directly to consumers and small businesses. There is no third option.
The problem with the TALF is that it ignores the new economic reality, that consumer demand has collapsed from the massive losses in home equity and retirement accounts. When credit markets froze last year, housing values dropped sharply raising havoc with household balance sheets and forcing a radical change in spending habits. That cutback in spending created a negative feedback loop to the financial sector which made it impossible to re-inflate the credit bubble. The ultimate size of the financial system will be determined, to large extent, by the capacity of people to borrow again which depends on many factors including job security, savings, and optimism about the future. Needless to say, the growing worry over a 1930s-type Depression will not help to lift spirits or improve the chances for a speedy recovery. That said, there are positive steps the administration can take now to restore confidence in the markets and put the ship o' state on even keel. These measures fall under three main headings; debt reduction (forgiveness), regulation and accountability. Confidence is not built on inspiring oratory or personal charisma, but concrete actions to reestablish a rules-based system that penalizes crooks and fraudsters. Recovery isn't possible without a strong commitment to these basic changes. (Editor's emphasis throughout)
"We've explained the difference between a recession and a depression before. But we'll do it again. A recession is a pause in an otherwise healthy, growing economy. A depression is when the economy drops dead." Bill Bonner, The Daily Reckoning
March 09, 2009 "Information Clearing House" -- There's good news and bad news. The good news is that Obama's economics team understands the fundamental problem with the banks and knows what needs to be done to fix it. The bad news is that Bernanke, Summers and Geithner all have close ties to the big banks and refuse to do what's necessary. Instead, they keep propping up failing institutions with capital injections while concocting elaborate strategies for purchasing the banks bad assets through backdoor transactions. It's all very opaque, despite the cheery public relations monikers they slap on their various "rescue" plans. This charade has gone on for more than a month while unemployment has continued to soar, the stock market has continued to plunge, and the country has slipped deeper into economic quicksand.
Paul Krugman summed up the administration's response in Friday's column, "The Biig Dither":
"There’s a growing sense of frustration, even panic, over Mr. Obama’s failure to match his words with deeds. The reality is that when it comes to dealing with the banks, the Obama administration is dithering. Policy is stuck in a holding pattern....
Why do officials keep offering plans that nobody else finds credible? Because somehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets ... are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away. ...
What’s more, officials seem to believe that getting toxic waste properly priced would cure the ills of all our major financial institutions.(Paul Krugman, The Big Dither, New York Times)
Krugman is right about the "dithering" but wrong about the toxic waste. Geithner and Bernanke know exactly what these assets are worth--- just pennies on the dollar. That's why Geithner has avoided taking $5 or $10 billion of these mortgage-backed securities (MBS) and putting them up for public auction. That would be the reasonable thing to do and it would remove any doubt about their true value. But the Treasury Secretary won't do that because it would just draw attention to the fact that the banking system is insolvent; the vaults are full of nothing but garbage loans that are defaulting at a record pace. Instead, Geithner has cooked up a plan for a "public-private partnership" which will provide up to $1 trillion in funding for private equity and hedge funds to purchase toxic assets from the banks. The Treasury will offer low interest "non recourse" loans (with explicit government guarantees against any potential loss) to qualified investors. If the hedge funds or private equity firms don't turn a profit in three years, they simply return the assets to the Treasury and get their money back. In essence, Geithner's plan provides a lavish subsidy to private industry on a totally risk free investment. It's a sweetheart deal.
At the same time, the plan achieves Geithner's two main objectives; it gives the banks the chance to scrub their balance sheets of junk mortgages and it also allows them to keep the present management-structure in place. The $1 trillion taxpayer giveaway to the hedge funds is just another juicy bone tossed to Geithner's real constituents-- Wall Street speculators.
Unfortunately, markets don't like uncertainty, which is why Geithner's circuitous plan has put traders in a frenzy. Wall Street has gone from scratching its head in bewilderment, to a stampede for the exits. In the last month alone, the stock market has plummeted a whopping 18 percent, indicating ebbing confidence in the political leadership. Geithner is now seen as another glorified bank lobbyist like his predecessor, Paulson, who is in way over his head. His lack of clarity has only added to the widespread sense of malaise. Markets require transparency and details, not obfuscation, gibberish and Fed-speak. This is how Baseline Scenario blogger Simon Johnson summed it up:
"Confusion helps the powerful... When there are complicated government bailout schemes, multiple exchange rates, or high inflation, it is very hard to keep track of market prices and to protect the value of firms. The result, if taken to an extreme, is looting: the collapse of banks, industrial firms, and other entities because the insiders take the money (or other valuables) and run.
This is the prospect now faced by the United States.
Treasury has made it clear that they will proceed with a “mix-and-match” strategy, as advertised....The course of policy is set. For at least the next 18 months, we know what to expect on the banking front. Now Treasury is committed, the leadership in this area will not deviate from a pro-insider policy for large banks; they are not interested in alternative approaches (I’ve asked). The result will be further destruction of the private credit system and more recourse to relatively nontransparent actions by the Federal Reserve, with all the risks that entails.
"The road to economic hell is paved with good intentions and bad banks."(Simon Johnson Baseline Scenario)
This is unusually harsh criticism from a former head economist at the IMF, but Johnson's analysis is dead-on. Geithner is putting the interests of the banks before those of the country. The "public private partnership" is just a convoluted way of avoiding the heavy-lifting of rolling up the banks, wiping out shareholders, separating the bad assets, and replacing management. The same is true of Bernanke's Term Asset-Backed Securities Loan Facility (TALF) which is another futile attempt to restart Wall Street's failed credit-generating mechanism, securitization. It was securitization (which is the conversion of pools of mortgages into securities) which got us into this mess to begin with. It doesn't do any good to restore an inherently crisis-prone system that only works properly when the market is going up. There are more efficient ways to recapitalize the banks than the PPP, just as there are better ways to promote consumer spending than the TALF. Treasury should be looking into debt relief, jobs programs and higher wages, instead of barreling blindly down the same dead end. There are solutions that do not involve artificially low interest rates, government subsidies for toxic waste or lavish handouts to hedge funds. They simply require a commitment to rebuild the economy on sound principles of hard work, productivity and fair distribution of the the profits.
Even industry cheerleaders, like the Wall Street Journal, are skeptical of Bernanke's TALF and have denounced it as just another boondoggle.
Wall Street Journal: “If you missed the first hedge-fund boom, now may be the time to put up your shingle. Looking at the terms of the Federal Reserve’s new Term Asset-Backed Securities Loan Facility, investors using it should be able to generate hefty returns with little risk. The TALF effectively turns the Fed into a generous prime brokerage.”
Who needs a free market when Obama's Politburo is more than willing to prop up private industry with hundreds of billions of tax dollars?
There is another part of Geithner's plan that is even more troubling, that is, after the banks sell their dodgy assets to the hedge funds, what will they do with the money? Consumers are retrenching, so the pool of creditworthy customers will remain small. And businesses are trying to work off existing inventory, so they won't be borrowing to increase investment or retool anytime soon. If the opportunities for lending dry up, the banks will be forced to seek unconventional means for generating profits. My guess is the banks will put a large portion of their money into hedge funds for commodities speculation, which will push the price of oil, natural gas and other raw materials into the stratosphere just like they did last year when oil shot up to $147 bbl. The banks really have no choice; 65 percent of their business was securitized investments. That door has been slammed shut for good.
"TOO BIG TO FAIL"?
The Financial Times economics editor Martin Wolf warned in Friday's column of the dangers of our present course. He said:
"If large institutions are too big and interconnected to fail... then talk of maintaining them as “commercial” operations... is a sick joke. Such banks are not commercial operations; they are expensive wards of the state and must be treated as such.
The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. (Martin Wolf, Big risks for the insurer of last resort, Financial Times)
Citigroup is now officially a "ward of the state" although CEO Pandit and his scurvy band of pirates are still allowed to collect their paychecks and hang out by the water cooler. Citi's survival depends on the reluctant generosity of the US taxpayer who is now its biggest shareholder. The mega-bank has slumped from $58 per share to $1 per share in less than 2 years. It's now more expensive to buy a grande latte at Starbucks than it is to buy three shares of Citi...and, at least with the Starbucks, the buyer gets a buzz on. There's no upside to the Citi deal. It's a dead-loss. The real question is, how long will Geithner let this joke continue before he does his job?
Wolf is correct to draw attention to the myth of "too big to fail". In fact, the Kansas Federal Reserve President, Thomas Hoenig made the same point in a PDF released this week:
"We have been slow to face up to the fundamental problems in our financial system and reluctant to take decisive action with respect to failing institutions. ... We have been quick to provide liquidity and public capital, but we have not defined a consistent plan and not addressed the basic shortcomings and, in some cases, the insolvent position of these institutions.
We understandably would prefer not to "nationalize" these businesses, but in reacting as we are, we nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis." (Too Big has Failed, thanks to Calculated Risk)
Hoenig and Wolf are smart enough to know that the problem is not as simple as it sounds. They know that the largest financial institutions are lashed together in a net of complex counterparty contracts--mainly credit default swaps (CDS)--which run into tens of trillions of dollars, and, that if one player is allowed to default, it could pull all of the others down the elevator shaft along with it. The problem could be resolved with proper regulation which would force all CDS onto a regulated exchange so that government watchdogs could make sure that they are sufficiently capitalized to pay off whatever claims are levied against them. But, so far, no one in Congress has taken the initiative to propose the necessary regulation. Thus, the taxpayer continues to pay off hundreds of billions of dollars of insurance claims against AIG, which was so grossly under-capitalized, it couldn't meet its own obligations. The AIG fiasco provides a window into the real motivation behind financial engineering and the alphabet-soup of complex debt-instruments. (CDOs, MBSs, CDS) Wall Street knew that the fastest way to fatten the bottom line was to circumvent minimum capital requirements and expand leverage to unsustainable levels. In other words, a system of debt-fueled capitalism with only specks of capital. It worked beautifully, until it didn't.
Nobel prize-winning economist, Myron Scholes, who helped invent a model for pricing options, added his voice to the growing chorus of angry reformers who think the CDS market should be scrapped altogether. According to Bloomberg News: Scholes said "regulators need to ‘blow up or burn’ over-the-counter derivative trading markets to help solve the financial crisis. The markets have stopped functioning and are failing to provide pricing signals... The “solution is really to blow up or burn the OTC market, the CDSs and swaps and structured products, and let us start over.” (Bloomberg)
Treasury and the Fed have taken the position that they will not fix the system until they are forced at gunpoint. This is a prescription for disaster, not just because of growing public frustration or the free-falling stock markets, but because the banks are just the tip of the iceberg. The other non bank financial institutions are brimming with mortgage-backed sludge that will require emergency treatment, too. MarketWatch gives us a glimpse of the magnitude of the problem in last week's article "Banks fall out of bed, Citi shares under a buck":
"Market strategist Ed Yardeni's latest research shows that.....80.6%, or $7.4 trillion, of the assets held by the S&P financials companies were Level 2," he said in a research report. Level 2 assets are so-called mark-to-model, which are carried at a value based on assumptions, not true market prices."
What does "Level 2 assets" mean? It means that the financial giants are short on liquid assets--like cash or US Treasurys--and loaded with sketchy mortgage-backed paper to which they have arbitrarily assigned a value that no one in their right mind would ever pay. The entire US financial system, including the pension funds and insurance companies, is one humongous debt-bloated time bomb that is set to blow at any minute.
Surprisingly, Bernanke thinks he can simply wave his wand and restart the moribund credit markets. That's what the TALF is all about. The problem is that even if the Fed buys all of the AAA securities held by the respective financial institutions, (most of them are non banks) that still only accounts for 20 percent of the bad paper on the books. Here's what Tyler Durden said on Zero Hedge web site:
"Unfortunately for Geithner, who apparently did not read too deeply into the data, the bulk of the $1 trillion decline in securitizations came from home equity lending and non agency RMBS (Residential Mortgage Backed Securities), which reflect the "non-conforming" mortgage market, i.e. the subprime, alt-A and jumbo origination, loans which are the cause for the credit crisis, and which are rated far below the relevant AAA level. The truly unmet market, which the Treasury is addressing is at best 20% of the revised total amount." (Tyler Durden, Could TALF be the biggest disappointment yet?, Zero Hedge)
That leaves Geithner and Bernanke with few good choices. Either they expand TALF to include crappy AA (and lower) graded securities--putting the taxpayer at even greater risk--or they devise some totally new lending facility that will bypass the financial institutions altogether and issue credit directly to consumers and small businesses. There is no third option.
The problem with the TALF is that it ignores the new economic reality, that consumer demand has collapsed from the massive losses in home equity and retirement accounts. When credit markets froze last year, housing values dropped sharply raising havoc with household balance sheets and forcing a radical change in spending habits. That cutback in spending created a negative feedback loop to the financial sector which made it impossible to re-inflate the credit bubble. The ultimate size of the financial system will be determined, to large extent, by the capacity of people to borrow again which depends on many factors including job security, savings, and optimism about the future. Needless to say, the growing worry over a 1930s-type Depression will not help to lift spirits or improve the chances for a speedy recovery. That said, there are positive steps the administration can take now to restore confidence in the markets and put the ship o' state on even keel. These measures fall under three main headings; debt reduction (forgiveness), regulation and accountability. Confidence is not built on inspiring oratory or personal charisma, but concrete actions to reestablish a rules-based system that penalizes crooks and fraudsters. Recovery isn't possible without a strong commitment to these basic changes. (Editor's emphasis throughout)
Sunday, March 8, 2009
The U.S. Financial System Is Effectively Insolvent: There is a grave risk of a global L-shaped depression
Editor's NOTE:
As regular readers are aware, this site has consistently warned since its inception about the imminent collapse of the US economy given our almost total loss of manufacturing infrastructure a direct result of aggressive outsourcing of jobs and off-shoring of production. Professor Roubini and a few others frequently posted here have been extremely accurate to date in their pronouncements and predictions vis a vis the US economic crisis particularly as concerns the US mega/investment banking system.
--Dr. J. P. Hubert
By Nouriel Roubini
March 07, 2009 "Forbes" March 05, 2009 -- -- For those who argue that the rate of growth of economic activity is turning positive--that economies are contracting but at a slower rate than in the fourth quarter of 2008--the latest data don't confirm this relative optimism. In 2008's fourth quarter, gross domestic product fell by about 6% in the U.S., 6% in the euro zone, 8% in Germany, 12% in Japan, 16% in Singapore and 20% in South Korea. So things are even more awful in Europe and Asia than in the U.S.
There is, in fact, a rising risk of a global L-shaped depression that would be even worse than the current, painful U-shaped global recession. Here's why:
First, note that most indicators suggest that the second derivative of economic activity is still sharply negative in Europe and Japan and close to negative in the U.S. and China. Some signals that the second derivative was turning positive for the U.S. and China turned out to be fake starts. For the U.S., the Empire State and Philly Fed indexes of manufacturing are still in free fall; initial claims for unemployment benefits are up to scary levels, suggesting accelerating job losses; and January's sales increase is a fluke--more of a rebound from a very depressed December, after aggressive post-holiday sales, than a sustainable recovery.
For China, the growth of credit is only driven by firms borrowing cheap to invest in higher-returning deposits, not to invest, and steel prices in China have resumed their sharp fall. The more scary data are those for trade flows in Asia, with exports falling by about 40% to 50% in Japan, Taiwan and Korea.
Even correcting for the effect of the Chinese New Year, exports and imports are sharply down in China, with imports falling (-40%) more than exports. This is a scary signal, as Chinese imports are mostly raw materials and intermediate inputs. So while Chinese exports have fallen so far less than in the rest of Asia, they may fall much more sharply in the months ahead, as signaled by the free fall in imports.
With economic activity contracting in 2009's first quarter at the same rate as in 2008's fourth quarter, a nasty U-shaped recession could turn into a more severe L-shaped near-depression (or stag-deflation). The scale and speed of synchronized global economic contraction is really unprecedented (at least since the Great Depression), with a free fall of GDP, income, consumption, industrial production, employment, exports, imports, residential investment and, more ominously, capital expenditures around the world. And now many emerging-market economies are on the verge of a fully fledged financial crisis, starting with emerging Europe.
Fiscal and monetary stimulus is becoming more aggressive in the U.S. and China, and less so in the euro zone and Japan, where policymakers are frozen and behind the curve. But such stimulus is unlikely to lead to a sustained economic recovery. Monetary easing--even unorthodox--is like pushing on a string when (1) the problems of the economy are of insolvency/credit rather than just illiquidity; (2) there is a global glut of capacity (housing, autos and consumer durables and massive excess capacity, because of years of overinvestment by China, Asia and other emerging markets), while strapped firms and households don't react to lower interest rates, as it takes years to work out this glut; (3) deflation keeps real policy rates high and rising while nominal policy rates are close to zero; and (4) high yield spreads are still 2,000 basis points relative to safe Treasuries in spite of zero policy rates
Fiscal policy in the U.S. and China also has its limits. Of the $800 billion of the U.S. fiscal stimulus, only $200 billion will be spent in 2009, with most of it being backloaded to 2010 and later. And of this $200 billion, half is tax cuts that will be mostly saved rather than spent, as households are worried about jobs and paying their credit card and mortgage bills. (Of last year's $100 billion tax cut, only 30% was spent and the rest saved.)
Thus, given the collapse of five out of six components of aggregate demand (consumption, residential investment, capital expenditure in the corporate sector, business inventories and exports), the stimulus from government spending will be puny this year.
Chinese fiscal stimulus will also provide much less bang for the headline buck ($480 billion). For one thing, you have an economy radically dependent on trade: a trade surplus of 12% of GDP, exports above 40% of GDP, and most investment (that is almost 50% of GDP) going to the production of more capacity/machinery to produce more exportable goods. The rest of investment is in residential construction (now falling sharply following the bursting of the Chinese housing bubble) and infrastructure investment (the only component of investment that is rising).
With massive excess capacity in the industrial/manufacturing sector and thousands of firms shutting down, why would private and state-owned firms invest more, even if interest rates are lower and credit is cheaper? Forcing state-owned banks and firms to, respectively, lend and spend/invest more will only increase the size of nonperforming loans and the amount of excess capacity. And with most economic activity and fiscal stimulus being capital- rather than labor-intensive, the drag on job creation will continue.
So without a recovery in the U.S. and global economy, there cannot be a sustainable recovery of Chinese growth. And with the U.S, recovery requiring lower consumption, higher private savings and lower trade deficits, a U.S. recovery requires China's and other surplus countries' (Japan, Germany, etc.) growth to depend more on domestic demand and less on net exports. But domestic-demand growth is anemic in surplus countries for cyclical and structural reasons. So a recovery of the global economy cannot occur without a rapid and orderly adjustment of global current account imbalances.
Meanwhile, the adjustment of U.S. consumption and savings is continuing. The January personal spending numbers were up for one month (a temporary fluke driven by transient factors), and personal savings were up to 5%. But that increase in savings is only illusory. There is a difference between the national income account (NIA) definition of household savings (disposable income minus consumption spending) and the economic definitions of savings as the change in wealth/net worth: savings as the change in wealth is equal to the NIA definition of savings plus capital gains/losses on the value of existing wealth (financial assets and real assets such as housing wealth).
In the years when stock markets and home values were going up, the apologists for the sharp rise in consumption and measured fall in savings were arguing that the measured savings were distorted downward by failing to account for the change in net worth due to the rise in home prices and the stock markets.
But now with stock prices down over 50% from peak and home prices down 25% from peak (and still to fall another 20%), the destruction of household net worth has become dramatic. Thus, correcting for the fall in net worth, personal savings is not 5%, as the official NIA definition suggests, but rather sharply negative.
In other terms, given the massive destruction of household wealth/net worth since 2006-07, the NIA measure of savings will have to increase much more sharply than has currently occurred to restore households' severely damaged balance sheets. Thus, the contraction of real consumption will have to continue for years to come before the adjustment is completed.
In the meanwhile the Dow Jones industrial average is down today below 7,000, and U.S. equity indexes are 20% down from the beginning of the year. I argued in early January that the 25% stock market rally from late November to the year's end was another bear market suckers' rally that would fizzle out completely once an onslaught of worse than expected macro and earnings news, and worse than expected financial shocks, occurs. And the same factors will put further downward pressures on U.S. and global equities for the rest of the year, as the recession will continue into 2010, if not longer (a rising risk of an L-shaped near-depression).
Of course, you cannot rule out another bear market suckers' rally in 2009, most likely in the second or third quarters. The drivers of this rally will be the improvement in second derivatives of economic growth and activity in the U.S. and China that the policy stimulus will provide on a temporary basis. But after the effects of a tax cut fizzle out in late summer, and after the shovel-ready infrastructure projects are done, the policy stimulus will slacken by the fourth quarter, as most infrastructure projects take years to be started, let alone finished.
Similarly in China, the fiscal stimulus will provide a fake boost to non-tradable productive activities while the traded sector and manufacturing continue to contract. But given the severity of macro, household, financial-firm and corporate imbalances in the U.S. and around the world, this second- or third-quarter suckers' market rally will fizzle out later in the year, like the previous five ones in the last 12 months.
In the meantime, the massacre in financial markets and among financial firms is continuing. The debate on "bank nationalization" is borderline surreal, with the U.S. government having already committed--between guarantees, investment, recapitalization and liquidity provision--about $9 trillion of government financial resources to the financial system (and having already spent $2 trillion of this staggering $9 trillion figure).
Thus, the U.S. financial system is de facto nationalized, as the Federal Reserve has become the lender of first and only resort rather than the lender of last resort, and the U.S. Treasury is the spender and guarantor of first and only resort. The only issue is whether banks and financial institutions should also be nationalized de jure.
But even in this case, the distinction is only between partial nationalization and full nationalization: With 36% (and soon to be larger) ownership of Citi (nyse: C - news - people ), the U.S. government is already the largest shareholder there. So what is the non-sense about not nationalizing banks? Citi is already effectively partially nationalized; the only issue is whether it should be fully nationalized.
Ditto for AIG (nyse: AIG - news - people ), which lost $62 billion in the fourth quarter and $99 billion in all of 2008 and is already 80% government-owned. With such staggering losses, it should be formally 100% government-owned. And now the Fed and Treasury commitments of public resources to the bailout of the shareholders and creditors of AIG have gone from $80 billion to $162 billion.
Given that common shareholders of AIG are already effectively wiped out (the stock has become a penny stock), the bailout of AIG is a bailout of the creditors of AIG that would now be insolvent without such a bailout. AIG sold over $500 billion of toxic credit default swap protection, and the counter-parties of this toxic insurance are major U.S. broker-dealers and banks.
News and banks analysts' reports suggested that Goldman Sachs (nyse: GS - news - people ) got about $25 billion of the government bailout of AIG and that Merrill Lynch was the second largest benefactor of the government largesse. These are educated guesses, as the government is hiding the counter-party benefactors of the AIG bailout. (Maybe Bloomberg should sue the Fed and Treasury again to have them disclose this information.)
But some things are known: Goldman's Lloyd Blankfein was the only CEO of a Wall Street firm who was present at the New York Fed meeting when the AIG bailout was discussed. So let us not kid each other: The $162 billion bailout of AIG is a nontransparent, opaque and shady bailout of the AIG counter-parties: Goldman Sachs, Merrill Lynch and other domestic and foreign financial institutions.
So for the Treasury to hide behind the "systemic risk" excuse to fork out another $30 billion to AIG is a polite way to say that without such a bailout (and another half-dozen government bailout programs such as TAF, TSLF, PDCF, TARP, TALF and a program that allowed $170 billion of additional debt borrowing by banks and other broker-dealers, with a full government guarantee), Goldman Sachs and every other broker-dealer and major U.S. bank would already be fully insolvent today.
And even with the $2 trillion of government support, most of these financial institutions are insolvent, as delinquency and charge-off rates are now rising at a rate--given the macro outlook--that means expected credit losses for U.S. financial firms will peak at $3.6 trillion. So, in simple words, the U.S. financial system is effectively insolvent.
As regular readers are aware, this site has consistently warned since its inception about the imminent collapse of the US economy given our almost total loss of manufacturing infrastructure a direct result of aggressive outsourcing of jobs and off-shoring of production. Professor Roubini and a few others frequently posted here have been extremely accurate to date in their pronouncements and predictions vis a vis the US economic crisis particularly as concerns the US mega/investment banking system.
--Dr. J. P. Hubert
By Nouriel Roubini
March 07, 2009 "Forbes" March 05, 2009 -- -- For those who argue that the rate of growth of economic activity is turning positive--that economies are contracting but at a slower rate than in the fourth quarter of 2008--the latest data don't confirm this relative optimism. In 2008's fourth quarter, gross domestic product fell by about 6% in the U.S., 6% in the euro zone, 8% in Germany, 12% in Japan, 16% in Singapore and 20% in South Korea. So things are even more awful in Europe and Asia than in the U.S.
There is, in fact, a rising risk of a global L-shaped depression that would be even worse than the current, painful U-shaped global recession. Here's why:
First, note that most indicators suggest that the second derivative of economic activity is still sharply negative in Europe and Japan and close to negative in the U.S. and China. Some signals that the second derivative was turning positive for the U.S. and China turned out to be fake starts. For the U.S., the Empire State and Philly Fed indexes of manufacturing are still in free fall; initial claims for unemployment benefits are up to scary levels, suggesting accelerating job losses; and January's sales increase is a fluke--more of a rebound from a very depressed December, after aggressive post-holiday sales, than a sustainable recovery.
For China, the growth of credit is only driven by firms borrowing cheap to invest in higher-returning deposits, not to invest, and steel prices in China have resumed their sharp fall. The more scary data are those for trade flows in Asia, with exports falling by about 40% to 50% in Japan, Taiwan and Korea.
Even correcting for the effect of the Chinese New Year, exports and imports are sharply down in China, with imports falling (-40%) more than exports. This is a scary signal, as Chinese imports are mostly raw materials and intermediate inputs. So while Chinese exports have fallen so far less than in the rest of Asia, they may fall much more sharply in the months ahead, as signaled by the free fall in imports.
With economic activity contracting in 2009's first quarter at the same rate as in 2008's fourth quarter, a nasty U-shaped recession could turn into a more severe L-shaped near-depression (or stag-deflation). The scale and speed of synchronized global economic contraction is really unprecedented (at least since the Great Depression), with a free fall of GDP, income, consumption, industrial production, employment, exports, imports, residential investment and, more ominously, capital expenditures around the world. And now many emerging-market economies are on the verge of a fully fledged financial crisis, starting with emerging Europe.
Fiscal and monetary stimulus is becoming more aggressive in the U.S. and China, and less so in the euro zone and Japan, where policymakers are frozen and behind the curve. But such stimulus is unlikely to lead to a sustained economic recovery. Monetary easing--even unorthodox--is like pushing on a string when (1) the problems of the economy are of insolvency/credit rather than just illiquidity; (2) there is a global glut of capacity (housing, autos and consumer durables and massive excess capacity, because of years of overinvestment by China, Asia and other emerging markets), while strapped firms and households don't react to lower interest rates, as it takes years to work out this glut; (3) deflation keeps real policy rates high and rising while nominal policy rates are close to zero; and (4) high yield spreads are still 2,000 basis points relative to safe Treasuries in spite of zero policy rates
Fiscal policy in the U.S. and China also has its limits. Of the $800 billion of the U.S. fiscal stimulus, only $200 billion will be spent in 2009, with most of it being backloaded to 2010 and later. And of this $200 billion, half is tax cuts that will be mostly saved rather than spent, as households are worried about jobs and paying their credit card and mortgage bills. (Of last year's $100 billion tax cut, only 30% was spent and the rest saved.)
Thus, given the collapse of five out of six components of aggregate demand (consumption, residential investment, capital expenditure in the corporate sector, business inventories and exports), the stimulus from government spending will be puny this year.
Chinese fiscal stimulus will also provide much less bang for the headline buck ($480 billion). For one thing, you have an economy radically dependent on trade: a trade surplus of 12% of GDP, exports above 40% of GDP, and most investment (that is almost 50% of GDP) going to the production of more capacity/machinery to produce more exportable goods. The rest of investment is in residential construction (now falling sharply following the bursting of the Chinese housing bubble) and infrastructure investment (the only component of investment that is rising).
With massive excess capacity in the industrial/manufacturing sector and thousands of firms shutting down, why would private and state-owned firms invest more, even if interest rates are lower and credit is cheaper? Forcing state-owned banks and firms to, respectively, lend and spend/invest more will only increase the size of nonperforming loans and the amount of excess capacity. And with most economic activity and fiscal stimulus being capital- rather than labor-intensive, the drag on job creation will continue.
So without a recovery in the U.S. and global economy, there cannot be a sustainable recovery of Chinese growth. And with the U.S, recovery requiring lower consumption, higher private savings and lower trade deficits, a U.S. recovery requires China's and other surplus countries' (Japan, Germany, etc.) growth to depend more on domestic demand and less on net exports. But domestic-demand growth is anemic in surplus countries for cyclical and structural reasons. So a recovery of the global economy cannot occur without a rapid and orderly adjustment of global current account imbalances.
Meanwhile, the adjustment of U.S. consumption and savings is continuing. The January personal spending numbers were up for one month (a temporary fluke driven by transient factors), and personal savings were up to 5%. But that increase in savings is only illusory. There is a difference between the national income account (NIA) definition of household savings (disposable income minus consumption spending) and the economic definitions of savings as the change in wealth/net worth: savings as the change in wealth is equal to the NIA definition of savings plus capital gains/losses on the value of existing wealth (financial assets and real assets such as housing wealth).
In the years when stock markets and home values were going up, the apologists for the sharp rise in consumption and measured fall in savings were arguing that the measured savings were distorted downward by failing to account for the change in net worth due to the rise in home prices and the stock markets.
But now with stock prices down over 50% from peak and home prices down 25% from peak (and still to fall another 20%), the destruction of household net worth has become dramatic. Thus, correcting for the fall in net worth, personal savings is not 5%, as the official NIA definition suggests, but rather sharply negative.
In other terms, given the massive destruction of household wealth/net worth since 2006-07, the NIA measure of savings will have to increase much more sharply than has currently occurred to restore households' severely damaged balance sheets. Thus, the contraction of real consumption will have to continue for years to come before the adjustment is completed.
In the meanwhile the Dow Jones industrial average is down today below 7,000, and U.S. equity indexes are 20% down from the beginning of the year. I argued in early January that the 25% stock market rally from late November to the year's end was another bear market suckers' rally that would fizzle out completely once an onslaught of worse than expected macro and earnings news, and worse than expected financial shocks, occurs. And the same factors will put further downward pressures on U.S. and global equities for the rest of the year, as the recession will continue into 2010, if not longer (a rising risk of an L-shaped near-depression).
Of course, you cannot rule out another bear market suckers' rally in 2009, most likely in the second or third quarters. The drivers of this rally will be the improvement in second derivatives of economic growth and activity in the U.S. and China that the policy stimulus will provide on a temporary basis. But after the effects of a tax cut fizzle out in late summer, and after the shovel-ready infrastructure projects are done, the policy stimulus will slacken by the fourth quarter, as most infrastructure projects take years to be started, let alone finished.
Similarly in China, the fiscal stimulus will provide a fake boost to non-tradable productive activities while the traded sector and manufacturing continue to contract. But given the severity of macro, household, financial-firm and corporate imbalances in the U.S. and around the world, this second- or third-quarter suckers' market rally will fizzle out later in the year, like the previous five ones in the last 12 months.
In the meantime, the massacre in financial markets and among financial firms is continuing. The debate on "bank nationalization" is borderline surreal, with the U.S. government having already committed--between guarantees, investment, recapitalization and liquidity provision--about $9 trillion of government financial resources to the financial system (and having already spent $2 trillion of this staggering $9 trillion figure).
Thus, the U.S. financial system is de facto nationalized, as the Federal Reserve has become the lender of first and only resort rather than the lender of last resort, and the U.S. Treasury is the spender and guarantor of first and only resort. The only issue is whether banks and financial institutions should also be nationalized de jure.
But even in this case, the distinction is only between partial nationalization and full nationalization: With 36% (and soon to be larger) ownership of Citi (nyse: C - news - people ), the U.S. government is already the largest shareholder there. So what is the non-sense about not nationalizing banks? Citi is already effectively partially nationalized; the only issue is whether it should be fully nationalized.
Ditto for AIG (nyse: AIG - news - people ), which lost $62 billion in the fourth quarter and $99 billion in all of 2008 and is already 80% government-owned. With such staggering losses, it should be formally 100% government-owned. And now the Fed and Treasury commitments of public resources to the bailout of the shareholders and creditors of AIG have gone from $80 billion to $162 billion.
Given that common shareholders of AIG are already effectively wiped out (the stock has become a penny stock), the bailout of AIG is a bailout of the creditors of AIG that would now be insolvent without such a bailout. AIG sold over $500 billion of toxic credit default swap protection, and the counter-parties of this toxic insurance are major U.S. broker-dealers and banks.
News and banks analysts' reports suggested that Goldman Sachs (nyse: GS - news - people ) got about $25 billion of the government bailout of AIG and that Merrill Lynch was the second largest benefactor of the government largesse. These are educated guesses, as the government is hiding the counter-party benefactors of the AIG bailout. (Maybe Bloomberg should sue the Fed and Treasury again to have them disclose this information.)
But some things are known: Goldman's Lloyd Blankfein was the only CEO of a Wall Street firm who was present at the New York Fed meeting when the AIG bailout was discussed. So let us not kid each other: The $162 billion bailout of AIG is a nontransparent, opaque and shady bailout of the AIG counter-parties: Goldman Sachs, Merrill Lynch and other domestic and foreign financial institutions.
So for the Treasury to hide behind the "systemic risk" excuse to fork out another $30 billion to AIG is a polite way to say that without such a bailout (and another half-dozen government bailout programs such as TAF, TSLF, PDCF, TARP, TALF and a program that allowed $170 billion of additional debt borrowing by banks and other broker-dealers, with a full government guarantee), Goldman Sachs and every other broker-dealer and major U.S. bank would already be fully insolvent today.
And even with the $2 trillion of government support, most of these financial institutions are insolvent, as delinquency and charge-off rates are now rising at a rate--given the macro outlook--that means expected credit losses for U.S. financial firms will peak at $3.6 trillion. So, in simple words, the U.S. financial system is effectively insolvent.
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