US Fed Behind the Economic and Housing Curve
Economics / US Economy Nov 29, 2007 - 06:56 AM GMTBy: Jim_Willie_CB
The US Federal Reserve is behind the curve. Great consequences have resulted and are likely to continue to result. Many words can be used to describe this group. What come to mind are inept, compromised, corrupted, distracted, ill-trained, but also clueless, deceptive, myopic, overly cautious, and off the market in their focus. When they remain transfixed on economic growth versus price inflation, they are stuck in the past, in a world that no longer exists. The corrupt spew of fraudulent mortgage bonds disseminated throughout the investment community has both crippled the banking system from profound distrust, and inhibited the USEconomy from credit supply fraught with obstacles. With their irresponsibly slow reaction to significant threats to the entire economic and financial system, the hapless USFed has put several things at grave risk. Since mid-September, the USFed has cut the official rate twice by a total of 75 basis points (0.75%), and reduced the discount rate.
These are minor steps. More important to the matter is the flimsy net aggregate action taken by them to provide desperately needed liquidity. Since many USFed official actions are merely temporary lending actions, withdrawn soon, whether overnight or for a full week, they can actually take away all medicine very soon after delivering it. In fact, John Hussman points out that the USFed on a net basis has injected only $15 billion into the banking system since March, a tiny sum given the $12 trillion size of that system. The USFed is dithering. The longer they dither, the bigger the gold response will be to the Final Solution, sure to center on a powerful gigantic Resolution Trust Corp, bigger than the previous one in 1991.
The banking system is burning, but the USFed firemen are still focused on the hustle & bustle of activity scurrying about the business centers surrounding the structure in flames. The misdirected firemen are still focused on the horrendously doctored price inflation figures. They seem more interested in denying the slowdown with powerful momentum in the USEconomy, replete with exaggerations to hide its current recession, than to address the problem in ways it can. They seem more interested in the boomerang effect of price inflation stemming from a weak USDollar, replete with laughable exclusions, substitutions, omissions, all useful to hide its current rampage in prices, than to address the problem in ways it can.
The USFed is suffering from a credibility problem. They are the object of rather harsh but deserved criticism, for being slow to address the situation effectively, and for ignoring the real problem. When the core of the banking system exhibits deep distrust from the cancerous toxins floating about, and cannot trust the lousy quality in financial collateral, the USFed must react to fix it. Unless and until the USFed removes toxins in grandiose style, the problem will persist. The remedy must be as grand as the problem. The medicine must match the sickness.
Powerful medicine is coming, which will ensure bigger rate cuts and bigger USDollar damage, the next impetus to power gold upward toward 1000 !!!
These guys are clowns, who are matched by greater clowns on the White House Council of Economic Advisors. They spend far more time lying about the economic condition, defending falsified perspectives, than they do in putting in place effective remedy, even for a burning building. Good riddance Al Hubbard. You are perhaps dumber than a run-of-the-mill ‘C' student in a secondary school, and that aint saying much. Your public comments have sounded more obtuse, clueless, and promotional than a toothless obnoxious loud barking pimp standing in front of a brothel to promote an aging unattractive inventory. Hubbard epitomizes the stupidity, blandness, and mental vacancy that dominates economic policymaking.
Is mental wattage no longer important in such crucial posts? John Snow established a pattern when his empty headed parroted commentary used to dominate the Dept of Treasury. Paulson has caught the Snow disease. Hubbard sees a housing problem, sees a mortgage bond problem, lies about job growth, but points blame to Congress for inaction while bipartisan bickering has rendered that once august institution useless. The whole world is watching, and the Untied States look like an embarrassment in stewardship. When not warranting shame from ineptitude, they provoke shame from corruption.
As the world reacts with disdain for the stewards aboard the USShip of State, they sell the USDollar and purchase gold .
The USEconomy had relied upon the housing boom as its perverse foundation for over three years, even endorsed by that monetary drug dealer Alan Greenspan. What did we once hear? A sophisticated economy was led by the financial sector, which benefited from financial engineering to reduce risk? A clean economy free of smokestack industry? An economy set to advance from a lower cost structure after massive unprecedented outsourcing to Asia ? An economy well supplied by reliable foreign sources of credit, their hard earned savings? Import dependence, including capital, is not an issue since trade partners are all our friends? Well, the harsh news is that the housing boom is a bust.
An economy cannot rely upon asset inflation. What a heretical concept! The main products from the financial sector are fraud, mispricing, leverage, and backfires, resulting in toxin and seizure, with a guarantee to unwind in seeming endless fashion as mutual distrust seethes. Wall Street favorite sons poisoned our credit suppliers. What a suicidal concept! The lack of income growth stems from jobs being shipped outside the country. Prosperity does not come from jobs sent overseas. What a moronic concept! A nation run by aggressive leaders with little concern over fiscal discipline, foreign resources, treaties, with a strong stick used in financial inter-relationships cannot expect heavy handed actions to go without retaliation. Stability, cooperation, and progress cannot come from intentional designed chronic import dependence. What a ludicrous concept!
LIBOR REJECTION
Perhaps the single most important global short-term interest rate is the LIBOR. The London InterBank Overnight Rate is used for supply of credit to adjustable mortgages, even in the United States . The LIBOR is used to supply credit to hedge funds, those villainous agents for speculation, who once were praised by Greenspan for assisting in offloaded risk. The LIBOR is used to supply credit for vast supply of credit derivatives, that mountain acting as a rooftop to cap prices for an assortment of things like long-term rates and gold.
The LIBOR is used to supply credit for a vast hoard of credit spread positions, which play USTreasurys against more risk laden securities like mortgage bonds and corporate bonds. The LIBOR has taken center stage in recent months, perhaps as a signal that London has superceded New York City itself. NYCity has clearly taken the mantle of the Financial Fraud capital of the world. London has eclipsed it in size and importance. LIBOR is its baby, not new by any means, but new in recognition across the Atlantic Ocean .
In the last two months, LIBOR has taken center stage. As corporate paper for interbank loans has shrunk massively in the United States , the source of LIBOR for interbank lending has become crucial. With higher demand comes a higher rate. However, a more important factor has made itself evident. The LIBOR rate has rejected the USFed solution to date so far. It has delivered a powerful ‘Vote of No Confidence' to the USFed itself and US bank sector. That vote loudly states that the USFed has not put in place any solution at all. The net $15 billion in system liquidity increase is woefully inadequate when banks distrust the collateral put up by other banks and major borrowers. The LIBOR 3-month rate has moved with an independent mind to the USTreasury short-term bond yields.
When the USTBill 3-month yield went from late August at 4.4% to late October at 3.95% to late November here at 3.08%, a firm trend was set. The 3-month TBill yield has fallen by a total of 1.38% since August. The LIBOR has not followed suit. Its 3-month interbank rate has moved from late August at 5.51% to late October at 4.98% to late November here back to 5.08%, in defiance. Its total move has been down by only 43 basis points. Above is shown the LIBOR one-month daily moves, which parallel the moves in the 3-month.
What does this mean? THAT THE USFED WILL CUT THE BENCHMARK INTEREST RATE AGAIN, BECAUSE THE US CENTRAL BANKERS HAVE NOT SOLVED ANYTHING. The USFed has failed to alleviate any credit problems, evident in actual credit flow. The credit markets continue to turn to London for the starved credit. One can make a credible argument that the USFed has taken its cue from S&P stock market droops. In August the credit problems, the banking fraud issues, the huge portfolio losses were all evident. In August the S&P500 stock index fell down sharply. The droopy swoon must have motivated the USFed to make their first official rate cuts.
Now with the S&P stock index once more drooping badly, instability in the stock market seems once more to motivate USFed Governor designee to make public pronouncements.
The Dow Jones index move up by over 300 points on Wednesday highlights both the effective response of the Fed Governor Kohn commentary made in the morning, and the motivation for making such comments. He spoke to the stock market. The USTreasury Bond market is well managed, as in manipulated, so as to support stocks. Despite foreign flight out of USTBonds, despite revolt by foreign central banks and their sovereign wealth funds, a phony ‘Flight to Quality' has been engineered. JPMorgan can take a bow for that project, using yet another small mountain of credit derivatives. In fact, the JPMorgan share of 2Q2007 credit derivative growth is larger than the entire market! Federal regulators are asleep at the wheel, which is to be expected when they not just are the federale's pockets, they are the federale's working agents.
Bear in mind that the Kohn comments, keeping the door wide open on additional official rate cuts, came the same day that US existing housing data was released from October activity. The housing market is nowhere near stability, or even leveling off. Existing home sales have fallen by 20.7% from October 2006 to October 20007. Well, that assumes no cancellations, so the decline is worse. The existing home inventory lifted by 1.9% to 10.8 months of supply. The national nightmare continues. Talk is lively on the extension of home price losses, and whether they will fall by 10% when dust clears. Try a figure at least twice that, maybe more.
A comment in fairness to the USTreasury Bond complex is necessary. There are two powerful sources of money being channeled into USTBonds lately, having nothing to do with manipulation. They are funds migrating from stocks into bonds, motivated to some extent by recession fears and withering corporate earnings. They are closed out US$-bound spread trades in bonds. A sector carry trade exists to go long the higher yielding higher risk bond like mortgages or junk, even corporate bonds, while going short the USTBond. For instance, as the mortgage spread trade ends, the anchor USTBond is covered. As the junk spread trade ends, the anchor USTBond is covered. The result is a short cover rally in USTBonds, advertised as a Flight to Quality, which in a narrow sense is true. The lie is that the flight is not global, since foreigners show signs of shunning US$-based securities.
CURRENCY WAR TIDBIT
Wrapped up in the day was a modest little USDollar bounce, exaggerated by the press in a manner that would befit gallows humor, except they were serious. The US DX index did not even manage a move to touch 76. Oh, by the way, that hefty euro selloff of over 100 basis points evaporated by end of day. One of the justifications for the big S&P stock rally was a rebounding USDollar. The Fed Beige Book report seems to set the stage for another USFed rate cut on December 11, since much weakness was reported.
The European Union has dispatched a team of emissaries to plead with the Chinese Govt on currency matters. With a sharply rising euro currency, and a managed slow upward revaluation of the Chinese yuan currency with respect to the USDollar, the euro has risen substantially against the yuan also. The Europeans want China to take steps to reverse the huge disadvantage left to European firms wishing to export to China . We might soon see a second exchange rate of yuan versus euro, but do not count on it. We have moved to the point where the Europeans are more vulnerable to Chinese mercantilism than the Americans.
The Chinese, as my analysis pointed out two years ago, will ravage the EU economy and built up surpluses from it, in a rotating fashion. Such is the nature of currency wars, as victims are rotated.
USFED NEEDED ACTIONS
Moral hazard has been in the news lately. What Kohn essentially said is that this is no time for morale hazards to be avoided, that the USFed might have to take very strong action, that the USEconomy is at great risk, that the US banking system is crippled enough to render harm to the economy. My forecast is for a 20% to 30% fall in home prices, depending upon creation of a serious Resolution Trust Corp. If they are going to permit a mammoth housing bubble, with an ugly leveraged bond extension, then an equally mammoth and equally ugly resolution structure is needed. Time is of the essence, while they dither. The USFed actions with rate cuts so far have been rather trifling, insignificant, and without substance. Salvaging Wall Street banks has been the hidden preliminary agenda.
The USFed has dithered so far. They are concerned about the morale hazard, about the perception of bailing out Wall Street banks, about a focused rescue. Of course, they are bailing out Wall Street banks, which are probably first in line at redemption tables. The USFed has been overly pre-occupied with its usual klapptrapp of economic growth versus price inflation. The bigger problem is banking system insolvency. The bigger problem is interrupted credit supply, from subprime hairballs stuck in the system. The bigger problem is distrust among bankers, enough to sidetrack many legitimate businesses who have difficulty finding adequate capital. The interbank system is replete with distrust and suspicion now. The Wall Street criminals have infiltrated the entire US banking system with toxins. The solution cannot be a measured reduction in interest rates by the USFed.
They seem hamstrung and dazed. So the USFed will be cutting interest rates again, as they see themselves as having no choice. This central bank is powerless to powerful market forces. The Fed Funds futures contract clearly indicates a total of 50 basis points in rate cuts by February 2008. Shown is a FF reading at 96.0, meaning 4.0% on the Fed Funds target rate. With a 2-year Treasury Bill yield at 3.17%, it too screams the USFed is behind the curve. The official Fed Funds target is 4.5%, which translates to the USFed being 1.3% wrong high. This presents supply & demand problems within the banking system itself.
My Hat Trick Letter has cited numerous simultaneous drastic measures needed to deal with the cluster of related problems. One is inadequate. They are all after effects of the housing bubble, since no bubble can exist and thrive to bubblicious proportions without a constant powerful stream of money.
The entire housing bubble and mortgage monstrosity apparatus is breaking, as the financial risk model is being unwound , without proper recognition. The USFed does not even recognize it, and if they did, they would not acknowledge it. The USFed must take historically unprecedented drastic action on numerous fronts. The Resolution Trust Corp must be put in place immediately. England has taken steps to restructure all adjustable loans so as to interrupt the foreclosure process. The knucklehead corrupt denizens of the US banking industry are too confused and compromised to accomplish much of anything. The RTC must have broad powers:
• To provide a floor bid on mortgage bonds, from ‘AAA' to ‘BB'
• To serve as a clearing house on traded mortgage bonds and their instruments
• To deliver dead mortgage securities to a cemetery
• To assist in renegotiated adjustable mortgages, in workouts
Until these measures are instituted, the USDollar will sell down continually. Until then, the USFed will lose integrity. Until then, the phony Flight to Quality in USTreasury Bonds will continue. Heaven help foreign FX reserve holders if both the USDollar and USTBond fall together! What we are witnessing is the US$ exchange rate used as a proxy vote against the USGovt leadership, against the US Federal Reserve leadership, against the Wall Street leadership. The US$ reflects lost confidence, structural brokenness, absent leadership, unbridled fiscal recklessness, utter locked ineptitude of Congress, perhaps even anti-militarism. In my view the US Congress has become a useless den of landlocked vipers, lobbied heavily, privileged heavily, and compromised fully.
An added ingredient could soon buttress the grand rescue package, whenever that occurs. Foreign deep pocket sources have decided, starting with the Abu Dhabi $7.5 billion stake in Citigroup, to provide some desperately needed equity. That represents a 4.9% stake. The cost to save Citigroup is dear, helped by a 11% junk bond type dividend. Yes, Citi is a vampire, walking dead, masquerading as a bank conglomerate, with what, 300 thousand employees? The trend will continue with Asian and Arab leading institutions ponying up valuable stakes of equity ownership, cold hard cash, to support the US broken insolvent system. The trouble is that many firms they will buttress are dead, so the stakes are to share the painful demise. They are assisting liquidity, but not solvency. If assets fail to surpass debts, then external cash for a stake merely shares the failure. The cash infusion was to avert bankruptcy by Citigroup , an event sure to garner some attention!!!
The US financial sector foundation is crumbling. Without such drastic action and coordinated measures, that financial sector foundation, fully networked with leveraged securities gone amok, the basis of the risk management regime, will continue to disintegrate. The longer the USFed & Dept of Treasury & Wall Street banks dither and hesitate, the more difficult the chartered job of the Resolution Trust Corp will be. The road to such an RTC plan is full of potholes. The Freddie Mac multi-billion$ loss was a brutal blow to anyone who actually maintained the lunatic notion that either Fannie Mae or Freddie Mac could conceivably serve as a foundation for any mortgage resolution platform. Well, unless a cover firm and thick enough can be constructed atop a financial sewage cesspool. What exactly would such financial cement look like??? Can paper act in such a role???
The longer the Powers That Be delay on the solution platform, the bigger the size of the platform rescue itself, and the greater the GOLD RESPONSE will be. The platform will spill liquidity from massive stimulus, enough to ignite gold. Unfortunately, the longer a delay in the Final Solution, the more damage done to speculative stock positions. They, like many other risk trades, suffer from the absence of risk capital.
Do not look to USFed Chairman Bernanke for guidance, to show the way out of the wilderness. Instead, look to him for an effective gauge on fear. He showed fear before Congress in his last appearance. In my view, he is a midget to fill a giant role. Greenspan would have recognized the gigantic systemic threat, but not the former Princeton University Economics Dept chairman. Remember, no bank operations experience, no business corporate experience, no financial market experience, no profit & loss experience. Bernanke was picked to be either the Fall Guy or the Puppet to control by Wall Street for its benefit. The USDollar will continue to be sold off, and gold will be pursued as a haven, as long as no serious solution is even discussed. The Wall Street SIV (Structured Investment Vehicle) was a sham seen as a potential bailout of Wall Street mortgage bonds, or a Hot Potato Party wherein nobody would step forward to handle such burning items.
SOCIAL CHAOS COMING
In the next several months, expect rising chaos to gradually strike the American fabric. The list of triggering factors grows almost with each new season. Look for problems and intense social reactions to extend from:
• Rising food prices, such as bread, milk, cheese, eggs
• Rising gasoline prices with scattered shortages
• Lost jobs from corporate outsourcing trend resumes
• Lost homes from bank foreclosure
• Later on, bank run on deposits at failed banks
• Later on still, freeze on stock accounts, as corporate parents go bankrupt
The ‘crack spread' describes the difference between the crude oil price and the gasoline price. It has widened to do harm to gasoline refiners. Unless a 50-cent move comes to the gasoline price, expect wide gasoline shortages. It is simply unprofitable to produce it. The food price issue is an offshoot from the mandated movement toward ethanol. In this crazy world, almost everything is connected.
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