Insolvent

SUBHEAD: The Black Hole of the US Banking System. 
 
By John Schettler on 22 January 2009 in The Writing Shop
Scores of streets were shut down and cordoned off, while nearly two million people flock to the scene to bear witness to a unique moment in history. Barak Obama, campaigning on hope and change, will be a welcome new beacon for a nation that has been stumbling through the insanity and darkness of the Bush-Cheney years for so long. His rhetorical skills will be a relief from the inarticulate bumbling speech of the misunderestimated “decider” he replaces. And Obama wasted no time framing the problems we face in one concise paragraph: “That we are in the midst of crisis is now well understood. Our nation is at war, against a far-reaching network of violence and hatred. Our economy is badly weakened, a consequence of greed and irresponsibility on the part of some, but also our collective failure to make hard choices and prepare the nation for a new age. Homes have been lost; jobs shed; businesses shuttered. Our health care is too costly; our schools fail too many; and each day brings further evidence that the ways we use energy strengthen our adversaries and threaten our planet.” Now, after the rhetoric, after the ceremony, the real work will still be before us, and it will be far more difficult than we realize.
image above: illustration by Steve Adams for http://www.camagazine.com/2/4/1/3/2/index1.shtml
Some feel the gala ceremony itself was the wrong message to send the nation in a time of great adversity. One intrepid blogger frowned on the inaugural ceremony this way: “In my opinion, Barack Obama should have canceled the inauguration celebration, re-directed all of the money set aside for the events to food banks around the nation, and modeled for the nation the sobering realities that we face. Instead he has chosen a grand and glorious wedding rather than a quiet marriage in front of a Justice of the Peace. He has opted for the ten thousand dollar wedding ring rather than weaving blades of grass together into a wedding band. And once the grand wedding is over, all of the drunk celebrants will return home and wake up on Wednesday morning with hangovers and less money in the bank and will scratch their heads and wonder what happens next.” The writer characterized the ceremony as nothing more than a dangerous false hope, and he could be correct if that is all we take from the moment. But in my opinion we need to start at least with that—with some sense of hope that we can take a new direction, build a new future—or what’s a heaven for? Just looking at the faces of the nearly two million people who flooded the Washington Mall, many traveling for 10 hours or more to reach the place and huddling in sub-zero temperatures for hours, was ample evidence that the ceremony was money well spent.
This is not to say that I underestimate the enormous work ahead of us now. As President Obama steps into office he will inherit a wrecked economy, staggering deficits, colossal national debt, and a financial system hemorrhaging from so many places that it is hard to determine how it could possibly be saved. As I stated earlier, like a building rigged for demolition, all the key underlying supports in the economy have already been blown. The building is falling, and it is simply too late for things like tax cuts, stimulus checks, and bailout money to forestall the collapse. Yet the prevailing talk is all about how to “get the economy moving again,” how to restore growth, create jobs, stabilize the banking system. This is the first great trap we must avoid if we are to truly revitalize this nation—our effort must not be to restore the old status quo, to return to the indulgent largesse of easy credit based consumption so that GM, Ford and Chrysler can find a way to remain in business. Far from it. Our first task is to realize that the old way of life we are all so accustomed to is not coming back. It was a life style financed through enormous financial hocus pocus, and built on a mountain of debt so high that it will now take generations to even begin to pay it down.
The facts of the matter are simply too grave to ignore. Think of our situation as a sand castle on the shoreline with a rapidly rising tide. What can we do? The waves have begun to eat away at the foundations, threatening to bring the whole edifice down. Do we scoop up more and more sand, like the billions in bailout money we’ve been throwing at the problem, and hope our castle can weather the storm?
Ben Bernanke defends the policies adopted thus far by the Treasury and Fed with another metaphor. He stated that “You have to put out the fire first. Then you can talk about changing the fire code.” His remarks explained the need for his own bailing policy, pouring on the liquidity in hundred billion dollar buckets. The intention is to somehow stabilize the banking system, but the glaring reality of insolvency is not yet being faced, openly acknowledged, or dealt with, and it may be that we have to let it all burn down and then build something new.
Bloomberg quoted Analyst Nouriel Rabini putting his incisive finger on the nub of the problem again: “I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital base of $1.4 trillion. This is a systemic banking crisis.”
Yes, let’s use the correct word. The banks are insolvent. The UK Independent also reported Tuesday: “Britain’s biggest banks are ‘technically insolvent,’ Royal Bank of Scotland said yesterday, as the global banking industry was rocked by another day of turmoil, including the announcement of $23bn of new losses from Merrill Lynch and Citigroup, the giant US institutions.” The article was subsequently pulled, and could only be accessed by viewing a cached page in Google. Clearly, no one wants the truth to be spoken openly.
The banks have been insolvent for years, but choose not to list their “assets” by any realistic current market value. By not “marking to market” they pretend that all the loans, securities, derivatives, CDOs, bonds, SIVs and other financial “instruments” they have created over the years are still worth what they were during the height of the housing boom, when in fact they would not be worth anything if sold in today’s market. These arrangements and gentlemen’s agreements the have banks made for their profit have all failed. The great misconception about what is happening in the financial markets is that banks need “liquidity,” to maintain normal operations. But the junk on their books is worthless, and can’t be sold. The game of securitization trades has come to a screeching halt. Because they can’t be sold or traded to the next schmuck in the investment chain, these former “assets” are now said to be “illiquid.” So the government pours on the cheap money thinking it has a liquidity crisis. But this is not a liquidity crisis, and never has been. It is a crisis of insolvency, though banks stolidly delude themselves, (and would be investors), with accounting tricks and secrecy that prevents any real understanding of the huge losses already on their books—losses that will only increase in the months ahead. It’s not that the securities can no longer be traded—the fact is, there is nothing of value there to trade! They are worthless! They are not assets at all, but huge liabilities, investments gone bad. The weight of these bad bets overshadows everything else on the bank balance sheet, so the banks simply remove it from their books in a fit of denial. But the basic fact remains—their liabilities exceed their real assets by a factor of many, many times. They are therefore insolvent.
The Global Europe Anticipation Bulletin (GEAB) wrote: “Contrary to what political leaders and their central bankers seem to believe worldwide, the problem of liquidity that they are striving to solve by means of historic interest rate drops and unlimited money creation, is not a cause but a consequence of the current crisis. It is in fact a problem of solvency which is digging black holes where liquidities disappear, whether we call these holes bank balance sheets, household debt, corporate bankruptcies, or public deficits.” This is exactly what we are seeing unfold. All the traditional havens for investment and wealth are now tar pits of insolvency. The world stock markets alone have lost a cumulative $22.2 trillion in wealth in 2008.
Consider that we have now thrown upwards of $9 trillion dollars at the financial system since September of 2008, a sum that is more that everything we spent in Korea, Vietnam, and the two Gulf wars, and still we get talk that if something isn’t done, something sweeping and dramatic, the system will fail. This tells you just how grave the situation really is. It tells you just how massive the liabilities and bad debts hidden on bank balance sheets actually are. When mid size banks like WaMu and Wachovia failed last year, they were gobbled up by larger institutions like BofA. Now the big boys have a stomach ache from all the toxic sludge they have swallowed. Citigroup is slowly cracking up like the Antarctic ice shelf, and calving off non-performing divisions into the sea of insolvency.
Bank Of America was “injected” with another twenty billion in emergency bailout money and then given a further backstop of $100 billion against future losses. They swallowed Countrywide and Merrill Lynch, and now the poison further sickens one of the nation’s largest banks. ( Financial Times reported that just before it failed, Merrill Lynch accelerated its bonus schedule and paid out $4 billion in bonus money on Dec 29, just three days before BofA took the institution over! In the last three months of 2008 Merrill Lynch lost $15 billion dollars, but still paid that same amount out in bonuses and compensation to employees in 2008. Amazing!) Now BofA owns the problem. It’s stock position erodes to what I call the “Starbucks” failure benchmark. With the price hovering near $5 a share the stock will soon be worth little more than a cup of coffee. So goes confidence in the whole system, vanishing into that bottomless cup, and any hopes that the Obama administration can do anything at all to halt the carnage may be misplaced. While talk of hope and change is a welcome effort to restore our confidence, it will not be enough.
President Sarkozy of France took a step in the right direction when he demanded top French bank executives give up all bonuses if they are to receive any government bailout money. “We ask banks that make a profit to finance the economy and not reward shareholders,” said Finance Minister Christine Lagarde. We could take that advice to heart over here as well, where huge allotments of the initial $350 billion in TARP relief money went into the bonus bin at all these failed institutions. Bonus money for insolvency. What a concept.
In England the situation is equally dire. UK Independent reported: “It is finally dawning on the Government that the liabilities of the British banks grew to be so vast in the boom years that they now eclipse the entire economy. Unfortunately, the Treasury is pledged to honor those liabilities because it has guaranteed not to let a British bank go down. RBS (Royal Bank of Scotland) has liabilities of £1.8 trillion, three times annual UK government spending!”
Is it any wonder that confidence in the financial system is in short supply these days? Regulators were stunned to discover that former NASDAQ head Bernie Madoff may have never executed a single trade in his titanic $50 billion dollar Ponzi scheme! In effect, he used his position and “credibility” to attract wealthy investor deposits, then simply created fraudulent statements, using money from one investor to pay another as they signed on. He made no real investment of the funds or market trades that yielded any real profit. It was all a great lie, and one that allowed him to skim countless millions, if not billions, in profits over the twenty odd years he plied his deceptive and criminal craft. Then, after being exposed and placed under house arrest, he “inadvertently” mailed millions in diamonds and other jewels to friends and relatives last week from his luxurious penthouse apartment. Where is justice? Roy Brown, a homeless man in Shreveport, was recently convicted for stealing $100. from a local bank, a crime that landed him a 15 year jail sentence. Madoff steals a cool $50 billion and is presently relaxing in his $7 million dollar penthouse estate and sorting through his jewelry collection. This vast disparity is a symbol of the basic inequity and unfairness of our entire system, where the “rich get richer and the poor stay poor.”
The damage wrought by men like Bernie Madoff, and countless others still wearing suits and ties in our financial institutions, is only now beginning to be revealed. If you think “sub-prime” loans were the culprit in all of this you are decidedly wrong. The gravest threats, all engineered by the banks and stately investment firms, still remain on the near horizon. While sub-prime loans may have accounted for $1.25 trillion, there are another $25 trillion in commercial real estate loans out there that are now in grave jeopardy. As corporations fail, like Circuit City closing 567 store locations, massive vacancies are now forming in the commercial real estate sector. Who will occupy those vacant suites? The answer is no one. The commercial sector is in the midst of a rapid contraction, and it will not recover for years. When these commercial loans begin to fail in significant numbers, and all the securities and derivatives sitting on top of them also become worthless, we will have a problem that dwarfs what we have seen so far.
These are the massive losses the banks are hiding on their books. They are the reason that the staggering sum of $9 trillion in bailouts have not unfrozen the credit markets, or restored confidence, and the reason that another $850 billion “stimulus” package will do nothing to solve the crisis. The damage will spread. Insurance companies, Federal Home Loan Banks, Pension Funds are all next in line to falter and fail. Who will bail them out? How much money can the government pledge when the US treasury itself is already bankrupt? The government has no money. It runs on a massive deficit that now exceeds a trillion dollars. Taxes will not pay for these bailouts. The money is being borrowed through treasury note sales, or simply printed.
There is talk about creating a large “bad bank,” an aggregator bank, that will absorb all these toxic losses, like a huge financial landfill. The idea is to get all the bad debt off the banks books and shovel it into one black hole that will then be sold to—you and me, John Q. Public, the humble taxpayer. Please understand what this means: the banks, private corporations, have incurred staggering losses from bad investment schemes. They now want to “sell” all these bad investments to a new government bank, funded by taxpayer money. In effect, they want to pass all their bad investments to you, to your children, and grandchildren so that they can regain solvency. This little idea is from the folks who brand you with a FICO score to see if they are willing to create a loan for you from thin air, then charge 30% interest on that credit to make you a debt slave for life. If that were not insult enough, they now ask you to absorb all the losses they have incurred with their wild, overleveraged speculation in securities schemes. This is outrageous!
Ilargi of the excellent blog “Automatic Earth” wrote: “Meanwhile, it doesn't help that governments refuse to help their citizens, but instead elect to put them deeper into debt by handing their money to banks, a move that doesn't just fail to aid the public, but is utterly contradictory to the public's best interest! What we see coming out of parliaments, government cabinets and presidential residences today doesn't solve anything, it makes it all much worse…Nobody talks about the fact that the banks—in all likelihood—have far too much of the paper than any government can afford to buy, provided at least they wish to have a functioning economy. The idea is that if they succeed in hiding what it is they buy, how much it is, how much (or little) it is truly worth, that they can get away with this. For the time being.” He believes we have just a few weeks for the banks to come clean and reveal the full extent of the losses now carried on their balance sheets. Otherwise confidence in the system as a whole will simply collapse altogether. Even as Obama spoke of hope, the markets fell nearly 4% on bad news from the banking system. That is a sobering reminder that the wolf is still at the door.
We so desperately need the hope Obama spoke of, but the great danger that hides behind a mask of hope is the belief that we can put Humpty Dumpty back together again as he once was. We cannot restore the system to its old leveraged glory, and get the milk and honey of easy credit flowing again to restart the game of “flip that house.” Gretchen Morgenson of the NY Times said it well with this assessment: “Clearly, the entire financial industry is in the midst of a makeover. And while no one wants to call it nationalization, perhaps we can agree on this much: The money business as we have come to know it over the last two decades — with its lush salaries, big-swinging risk-takers and ultrathin capital cushions — is a goner. Got that? Toast. Toe-tagged. And that’s a good thing, because maybe we can go back to a banking model that is designed to do more than simply enrich the folks at the top of the enterprise while shareholders and taxpayers absorb all the hits.”
Recovery must begin with accountability, transparency, and real responsibility from the banks. They must suffer the pain of their own misdeeds. This means no bloated CEO salaries, not a nickel in bonus money, no dividends paid out to “investors” whatsoever. You don’t get dividends for a loss. And that is just a starting point.
John Heinzl of “Your Money” had it right when he wrote: “What was the root cause of this mess we're in? Everybody understands that this happened because there was no regulation. But you have to ask the next question: Why wasn't there any regulation? And the answer is [U.S. politicians] were being paid to deregulate. They were accepting enormous campaign contributions from corporations, banks, hedge funds and Wall Street institutions. So the entire system has to change? They have to get big-business lobbying and corporate campaign contributions out of Washington. It's not that our government is ineffective. It's just not effective working for the American taxpayer. It has a different boss. It's working for its biggest contributors.” Following the tally of bailouts also tells this same story. The banks got $9 trillion in loans, guarantees and backstops. Joe taxpayer got a $300 rebate check, and then he and all his future generations will get the bill for that $9 trillion.
The hope of change that president Obama brings as he assumes the office must be more than a change of faces and personalities. It is clear we have a change of attitude and intentions in the new administration, but time is running out fast in the rapidly eroding financial sector. If restoring the old system becomes the goal, then we will only end up with half measures and more multi-billion dollar fingers in the dike—a lot of wasted effort and money. When these fail we may be one step closer to change that will come in a most unwelcome form in this country—change that may be far more uncomfortable that anyone has seen in America since the Civil War.
How ironic that Obama swore his oath on Lincoln’s bible. He will face a maelstrom every bit as severe as Lincoln did if we do not make drastic and immediate reforms in our banking system. By drastic I am speaking of changing the rules of the banking game at a fundamental level. Abolish the Fed, a conglomeration of private banks that wreak bubble havoc on the economy by rigging interest rates and printing money willy nilly. And no more “fractional reserve lending,” where money is created by banks on a whim when they literally “make” a loan, and these loans are backed by only a small fraction in actual reserves. You lend what you have taken in as deposits, nothing more. I’m not holding my breath that this will ever happen. Change only goes so far. Banking, as a business, may be inherently corrupt, but it is too deeply entrenched to be rooted out without something as cathartic as the French or Russian Revolutions. These things have happened before, and could happen again. Just ponder the fate of the Romanovs.
In Europe the situation is already skirting the edge of that potential violence as the Baltic states joined Greece with rioting in the streets. Protesters flung huge chunks of ice, smashing up the financial district in Latvia and threatening to storm parliament. The UK Telegraph reported: “Events are moving fast in Europe. The worst riots since the fall of Communism have swept the Baltics and the south Balkans. An incipient crisis is taking shape in the Club Med bond markets. S&P has cut Greek debt to near junk. Spanish, Portuguese, and Irish bonds are on negative watch….A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece's social fabric is unraveling before the pain begins, which bodes ill.”
Could it happen here? President Obama referenced our own revolution as a guidepost to the change he wants to inspire. If things get much worse, and the real truth about our banks is known, the people just might take him up on that idea. “If the public had any real understanding of how the banking system works,” said Henry Ford, “there would be a revolution in this country overnight.” In the short run, however, we will get new policies, bailout programs, stimulus packages, and tax reform, all aimed at righting the sinking ship and restoring the old game. It is a dangerous misconception of the enormity of our current crisis.

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