28 December 2009


economic analysis

US debt dwarfs the rest of the world. The graphic (courtesy of MarketTicker) shows the growth in US debt by various sectors at 1990, 2000 and 2010. The image is terrifying. This is why there will never be a soft landing in the current US economic crisis.

The sub prime mortgage crisis of 2009 is just a natural product of an underlying economic malaise that started with Reagan and the US hard Right and shot to the moon under George Bush Jnr. It might not have been noticed by the mainstream press but it certainly did not escape the attention of the financial markets that Bush stole both the 2000 and 2004 Presidential elections and that the corporate looting of the US Treasury was now on for the big banks.

For over thirty years the US Republican Party has transferred an unprecedented amount, so that now 90% of all US wealth belongs to a tiny elite of 1% of Americans. The middle class has been denied wage increases as a result of productivity gains, their jobs have been exported offshore, or replaced by green card migrants at lower wages. Essentially they have been financially gutted. Loading them with housing debt, crashing the property markets and off-loading corporate debt onto the US taxpayer as has occurred in the last 18 months has all been part of the plan.

The sub prime mortgage crisis started as a means of the big US banks getting mortgage debt off their books. With the overturning of the Glass-Steagall Act under Clinton, banks, whose consumer savings were guaranteed by the FIDC, were now allowed to operate non-banking functions such as stock-broking and insurance. So the banks took their mortgages (or more often, the risk associated with those mortages) and on-sold them to their own broking subsidiaries who "securitized" them into pooled investment funds. They then paid ratings agencies to rate these funds as AAA (which they were'nt) and onsold them to institutional investors like foreign governments and superannuation funds which only bought AAA products.

Also, from 2000 onwards there was also an explosive growth of the derivatives market, much of it outside the stock markets and most of it unregulated. The nominal "value" of all this derivatives "paper" was about 70 times the actual value of the real global economy, the economy that buys and sells actual stuff like cars, clothes and food. This derivatives economy was so large that they could not use ordinary banking so they started using US treasuries and other AAA rated corporate investment items as security for their trading. But even this was not enough, so they started using -- you guessed it -- the AAA mortgage crap which had been sold by the US banks who found the market for their pooled investment products so lucrative that they started issuing huge mortgages on inflated property prices to anyone who could sign a piece of paper just to put together a new mortgage investment package.

The inevitable happened in mid 2009: the US property market turned down and waitresses on $7.50/hr could no longer pay for their $500,000 homes. They defaulted and the contagion spread to the pooled investment funds based on those mortgages which were highly geared, some as much as 100:1. Suddenly, pension funds in Norway and Ireland were worth 10c on the dollar. People's life savings were gone. Moreover, those pooled investment funds had been sliced and repackaged so many times that there was no way of telling which, if any, of the AAA investment funds were safe and which were worthless. And all of these securities were the financial backing of the massive global derivatives market. Overnight, these securities became worthless as collateral and the entire financial markets ground to a halt.

The Bush and incoming Obama administrations immediately bailed out the big US banks and brokerage houses with $700 billion. But that was only a tiny part of the story. The banks receiving the $700B immediately awarded themselves 10% as commission! -- that's $70 billion! As well, the US government committed itself through various means to over $12 trillion of bailout obligations as a result of failed derivatives trades. That's $12,000 billion or $40,000 for every man, woman and child in the US. Some commentators even put the bailout figure at $23 trillion. Remember, the global derivatives market is not based on real goods but is a highly geared form of casino gambling that is 70 times larger than the real global economy and is essentially run by five big US banks. Even a tiny loss in their real asset backing (such as was induced by the sub prime mortgage crisis) results in a massive paper loss but it is important to remember that such losses are exactly that -- losses on paper.

The real criminality of the sub prime mortgage scam was that those five big US banks convinced the US government to shift those massive derivatives debts onto the shoulders of the US taxpayer to be paid for over fifty years or so by massively reducing public services: schools, hospitals, roads, jobs. It's a criminal scam. Paper debts have been replaced by real assets.

The US Federal Reserve has simply been buying up worthless stock using Treasury notes in defiance of explicit legislation prohibiting them from doing so. Treasury notes are US government IOUs that pay interest and foreign governments, like China, buy them in order to return US dollars, obtained through exports, to the US. The problem is that if the US keeps selling US Treasuries in order to fund the financial markets bailout then those Treasuries become less valuable. With the prospect of the US defaulting on its national debts growing larger (as Argentina did in the early 1990s) then buying Treasuries becomes riskier. That's why China has recently stopped buying them and the US government has had to rely on the Treasury Auctions "buyers of last resort,” US brokerage houses who agree to buy unsold Treasuries. So who are these "buyers of last resort"? Why, they are the big US banks that failed in 2009, the main recipients of US government bailouts, using bailout money to buy Treasuries to fund the bailout! We have finally entered the realm of "funny money", where a devaluation of the US$ is inevitable. The Federal Reserve is bankrupt. The only question being whether or not the US real economy is in for a hard or soft landing.

Let me break it to you gently: there is absolutely no way the US can avoid a catastrophic hard landing.

That is, unless the US:

(i) refuses to support the big US banks and brokerage houses and lets them go bankrupt.
(ii) institutes a massive program of financial support for jobs creation a la Roosevelt.
(iii) repeals the Bush tax breaks to the wealthy and claws back US bailout funds.
(iv) stops the expensive wars in Iraq and Afghanistan (illegal and immoral, anyway).
(v) massively cuts Defence Industry expenditure.
(vi) reforms the US health system with a single payer public health option.
(vii) repeals the Glass-Steagall Act and restricts banks to just banking.
(viii) controls derivates markets with end-of-day mark to market valuations.
(ix) prosecutes financial fraudsters for the massive financial crimes they have committed.
(x) works with foreign governments to provide a global response to this crisis.

Since the hard Right and ultra wealthy elements of the US have no intention of doing any of this the outcome can only be a US, and possibly global, economic collapse. The Obama government, supposedly Democratic, is packed with Wall Street insiders. As a distraction the US will almost certainly start a war, likely with Iran.

But, you say, haven't the share markets been booming following the bailouts? Yes, they have but when you check the numbers you find out that very little of that money has been coming from ordinary investors; most of it has been coming from the big US banks using the bailout money provided by the US government. The initial funding for those bailouts is due to stop in March 2010. The US sharemarket and the rest of the markets will then head down hill again.

There are also major negative factors about the US economy which are yet to play out:

(1) 2010 will see the start of a second US housing crisis -- bigger than the sub prime mortgage crisis -- and expected to run for at least two years. This is the "adjustable rates mortgage (ARMs)" crisis. For a number of years many US mortgages were offered at low, "teaser" rates such as 3%. Most of these are due to "reset" over the next two years at 12-15%. With US real unemployment at 20% we will see a further massive downturn in the US residential property market, a glut of unsold properties, depressed prices and greater unemployment.

The fact is the US consumer is "maxed out" on debt with rising unemployment and no way to pay. More than 60% of US residential mortgages have negative equity: that is, the owner owes $300,000 on the mortgage on a property worth only $220,000 in today's market. There is no way for this market to recover in the present economic climate. The temptation for ordinary homeowners to simply "send in the keys" and walk away is going to be overwhelming.

(2) US commercial property markets are crashing and those figures, which have been hidden till now, can be expected to pile drive the US share markets into the ground. US shopping malls are going to become silent masoleums.

(3) The Federal Deposit Insurance Commission (FDIC) is a guarantor of all US bank savings deposits. If a bank goes broke, the FDIC returns the savings to the depositor. Where does the FDIC get the money? – it has a line of credit to the US Treasury which obtains the funds by selling US Treasury notes on the public market. As we have seen, sales of US Treasury notes have been failing. The FDIC has bailed out something like 180 banks in recent months. Draw your own conclusions.

(4) The major US banks and brokerage houses are all bankrupt and are lying about their worth.

(5) There are good arguments that the US financial system has been deeply criminalized and that the current US leadership intends to back Goldman Sachs, Citigroup and JP Morgan Chase to further US global financial interests. (Meanwhile Greece, Iceland, Latvia and most of Europe are all staring into the financial abyss).

The US economy can never be healed until the unhealthy domination of US financial markets over the real, productive economy is finally broken and US politicians implement the ten major reforms mentioned earlier. Since the US hard Right, the financial sector and the Republican Party will never agree to this we can expect a collapse of the US economy, society and political consensus.

Recommended commentators:

Karl Denninger
Mike Whitney
Paul Craig Roberts
Matt Taibbi
Pam Martens
Nouriel Roubini
Janet Tavakoli
Henry Liu

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