great ticker by KD.....the hedgies must be salivating at this:
market-ticker.org
Saturday, February 7. 2009
Posted by Karl Denninger at 13:48
The Swindle Continues....
What a weekend of news we have here....
Unfortunately, news has overrun the topic of my Ticker for the weekend, which was The Federal Reserve. Well, partially overrun.
There are a whole host of people out there who have somehow gotten into their head that there is some evil 400-year-old Jewish Banking Cabal (plus or minus 100 years) that has an intergenerational conspiracy to steal everyone's money and property.
Folks, if you're in that camp, you might want to stop reading, or at least, go to the second half of The Ticker for today.
Let's dispense with a few things, one at a time:
The Fed is a private bank: Half true. The Federal Reserve is privately owned by its member banks which in turn are privately owned by their members. However, The Fed is operated not for the private profit of its owners, but rather with the gains and losses born by The United States Treasury. This is, in fact, why I rant and rave about The Fed's actions when they go beyond The Federal Reserve act of 1913 (formally Title 12 Chapter 3 of US Code) because losses are taken by the United States Treasury, that is, the taxpayer. If The Fed was a private bank then losses would be born by its members - and they're not. Likewise, profits are not given to its members - they belong to the Treasury (such as they are.)
But Fed Member banks have mandatory stock purchase by member banks and that stock pays a dividend: True. However that dividend is statutory (6%) and does not grow or shrink with the debt, currency, or trading activity (profit or loss) undertaken by that bank in the system, or the system as a whole. The stock issued is a special restricted stock and the money paid forms the capital base of that regional Federal Reserve Bank.
But money is debt: Indeed. Because both profits and losses flow through to Treasury, the argument that Treasury "pays a private bunch of banksters to borrow its own money into existence" is false. If I loan myself $100, is there a net impact? Likewise, if the profits and losses flow back to the source of the issued funds (Treasuries) where is the problem?
The Fed is not audited: Nonsense. Go look it up. Congress has full audit authority and in fact there are annual audits performed; Congress can also call for additional auditing activity any time it would like.
The Fed District Banks are private and steal our money: Nonsense.
The net earnings derived by the United States from Federal reserve banks shall, in the discretion of the Secretary, be used to supplement the gold reserve held against outstanding United States notes, or shall be applied to the reduction of the outstanding bonded indebtedness of the United States under regulations to be prescribed by the Secretary of the Treasury. Should a Federal reserve bank be dissolved or go into liquidation, any surplus remaining, after the payment of all debts, dividend requirements as hereinbefore provided, and the par value of the stock, shall be paid to and become the property of the United States and shall be similarly applied. "
Any questions?
Banks Must Become Members of The Fed System; this is wrong: No, this is right! You want to be able to obtain collateralized loans against the future productivity of The United States, backed by Treasury? Then you join the group that does this.
Fiat money causes Depressions and we should go back on a gold standard: Uh uh. Both the 1929 crash (and subsequent 1930s Depression) and the Panic of 1873 (which led to a monstrous Depression) occurred while The United States was on "hard money" - that is, a bimetallic monetary base of gold and silver. United States Dollars were at that time exchangeable for gold or silver on demand -they were known as "demand notes" as opposed to "federal reserve notes." FDR partially dismantled this part of our currency system with Nixon completing it when he closed the Gold Window. In any event monetary systems based on "sound money" or "hard money" have absolutely nothing to do with credit bubbles which are the root cause of nearly all monetary panics and crashes, dating back to Tulip Mania and beyond. Focusing on that which is not the cause of a situation leads one to bad conclusions and even worse results.
This is all a conspiracy by the 1% to take everything from the 99%: Oh really? Let me guess - if you believe this you're one of the people who borrowed money to build your own personal housing (or other business) empire and it blew up in your face? You got a fancy OptionARM so you could have your "Dream House"? You bought a boat or other toys on credit? You used credit cards and other forms of borrowing to fund a business (statistically, 9 out of 10 small businesses fail within five years.) How about some facts for you, chief among them being that quite a few people didn't do that in the 1920s; they saved like madmen and during the 30s they bought assets for pennies and became fabulously wealthy in the decades that followed. They weren't part of the 1%. There are plenty of people who didn't overspend and take on leverage during this last decade - they'll be fine and weren't part of the 1%. I personally did this during the 1990s; I started with literally nothing in the 1980s and never borrowed a penny to fund the operations of my company; as a consequence I was not beholden to the "must sell or IPO now" craze and didn't get caught in the tech bust, and did fine. Using leverage is gambling and when you lose in Las Vegas you don't blame the Casino for that loss do you - after all, did they force you to sit at the blackjack table?
So why do I rant and rave about The Fed quite frequently?
Mostly because The Fed has undertaken policy actions that are quite clearly beyond their statutory authority. The ability to put a stop to that is vested in Congress and the Executive Branch (e.g. the FBI and Secret Service, which deal with banking crimes) yet The Federal Reserve Act does not specify criminal or civil penalties for violations - ergo, enforcement must come from Congress in the form of additional legislation to specify penalties and/or to threaten revocation of The Federal Reserve Act itself. Thus far, they have refused to discharge their responsibility - which makes what The Fed has done unlawful, but without legal recourse in the form of a criminal penalty. This is somewhat like making a law against Bank Robbery but then specifying no penalty - so now you catch a bank robber, he's guilty, but what do you do about it? This is the problem - and where the solution needs to be employed.
Now let's talk about the weekend news....
The NY Times has an article on the new "bank rescue" program that states:
No matter what it is called, the government would assume some of the risk of declining assets at the heart of the economic crisis. But by relying on a combination of private investors and government guarantees, the administration hopes to reduce its exposure to losses and avoid the problem of having to place a value on assets that the institutions have been unable to sell.
A central element of the plan would be a major expansion of a lending facility begun in November by the Federal Reserve Bank of New York when it was headed by Mr. Geithner. The program, which was initially financed by $200 billion in Fed money and $20 billion in seed capital from the $700 billion bailout fund, lent money to investors to buy securities backed by student, auto and credit card loans, as well as loans guaranteed by the Small Business Administration.
This is an ugly deal folks; its the "TALF" reincarnated. The ugly part is found here in this WSJ article:
"Depending on the different types of collateral, investors will get roughly $100 of lending for every $5 to $16 of cash they put up to invest. The rate investors will have to pay will be set at one percentage point over interest rates based on London interbank offered rates.
The loans the Fed makes to investors are nonrecourse, meaning investors can't lose any more than the money they put upfront on the security. If a hedge fund defaults to the Fed, its collateral is the securities themselves. There also are no margin calls, meaning the Fed can't demand additional payments of cash from borrowers if the underlying securities fall in value.
Investors see these as important inducements to the program. But a Treasury Department inspector general warned that the program was vulnerable to fraud by the private sector."
Ugh. Here's the issue folks - "non-recourse" loans aren't loans in the traditional sense and they certainly aren't "discounting a note." This is an example of the blatantly unauthorized activity by The Fed.
The Fed justifies this under the "exigent circumstances" clause in The Federal Reserve Act which allows it to make loans to corporations and even individuals (as opposed to just banks) in the event of market dislocations. However, nowhere is The Fed authorized to make loans not backed by collateral or to take ownership of assets with the exception of Treasuries and other agency securities backed by The Full Faith and Credit of The United States Government - even under exigent circumstances!
The potential fraud problem with this program is immense and allowing Hedge Funds (as they apparently intend to do) into the mix makes it even worse. Without recourse if The Fed miscalculates the haircut required to be protected since losses at The Fed flow back to Treasury this is an unallocated spending of taxpayer dollars, which is explicitly unconstitutional (all spending bills must originate in The House.)
To the extent The Fed's exposure is capped at the spending authorized in The Tarp, this might pass constitutional muster. But in that case the total amount of assets that can be put into the program is whatever TARP II funds are allocated, and that clearly is not their intent - the intent of the TALF is to use the normal fractional reserve lending paradigm to lever up at somewhere between 8:1 and 15:1 on those assets for the people who "buy and tender" them to The Fed. As such if they allocate $100 billion of TARP II money to this program the maximum exposure could be anywhere from $800 billion to $1.5 trillion, yet the maximum allowed legal exposure to Treasury is the authorized $100 billion dollars.
While restarting the markets for these securities is an important function one must realize that there already is a market for them. The reason they are not trading is a fundamental disagreement on value. The banks are holding these assets at (for example) 95 cents on the dollar in "value", while the market says they're worth 20 cents. There are plenty of buyers at 20 cents, there might be a few at 25 cents, but there are none at 95 cents.
If The Fed comes in and offers to take them at 85 cents (haircut 15 from par) and they turn out to be worth at least 85 cents, then The Fed doesn't lose anything, the taxpayer is fine, the banks book the 10 cent loss against current market prices and those who buy them have whatever spread they can obtain to lever up with. If a hedge fund can lever up at 10:1 against this and make 10% they will make a hell of a lot of money - and provided the collateral performance doesn't go below 85 everything seems ok.
But what if the market price - the 20 cents - is the real value? Then there's a problem - the hedge funds get their cash flow on these assets for however long it lasts but their capital invested was only 1/10th of the face value and the loan is no-recourse.
Let's say Sir Hedgie has $100 million of these "assets"; he requires only $10 million in cash. Let's further assume that these "assets" kick off an aggregate coupon of 10% at their current discounted acquisition price.
If Sir Hedgie gets one year of performance in payment of that coupon before it all goes boom, he's ahead because if the explosion occurs later he simply doesn't care. The important part is that he is ahead even if a year from now the securities turn out to be worth exactly nothing, since he can only lose his $10 million in original capital he gives to The Fed, not the levered amount he has in securities.
So who eats the $90 million in losses? The Fed does, and guess what - it flows through (see the top of this post) to Treasury, which means you eat it.
The problem with this scheme is that if they put $100 billion into it through the leverage they're allowing there could be a full trillion of assets in this pool, yet the Hedge Funds only have $100 billion at risk (10:1 leverage) and no recourse. So if the paper goes bad there's $100 billion in capital held by The Fed against the loss, but if recovery ends up being 50 (against the discounted purchase price) then the other $400 billion in losses is taken directly by The Federal Reserve and passed through - without a spending bill allocating that $400 billion.
The Fed and the rest of the Banksters (including Treasury) are counting on you and Congress both to be too stupid to understand the risk exposure here and why this is both unconstitutional and must not be permitted. They obfuscate what they're doing through multiple layers of BS and bluster, when in the end the bottom line is that they're trying to restart leveraged lending against trash, where they have every reason to believe that the ratings on these securities are worthless and in fact the paper is contaminated at best.
It's a scam, but you can bet it will rocket the stock market if they can manage to slip it under people's noses - for a while.
The more interesting result will be what the bond market thinks of this.
Most of those folks have an IQ larger than their shoe size. |
