A Dose of Reality About the Cause of this Crisis (and the solutions)

[David Farber <dave () farber net>]

BTW both parties are to blame djf


Begin forwarded message:

From: Martin Burack <marty () burack nu>
Date: October 17, 2008 11:06:50 AM EDT
To: dave () farber net
Subject: A Dose of Reality About the Cause of this Crisis (and the  
solutions)

Dave,

The right-wing bloviators have spent their time blaming Fannie Mae and  
the Democrats for the current crisis.  They blame lending to  
minorities, of course.  They keep pointing to Franklin Raines being  
ousted in 2004 as CEO of Fannie Mae with millions in a pension, but  
never mention AIG's Sullivan leaving with millions.  They point to  
Fannie Mae and Freddy Mac lobbyists contributing to Senator Dodd and  
Representative Franks, but never mention that McCain's current  
campaign manager headed a firm that collected millions in lobbying  
fees from Mae and Mac.  They never mention Bush's SEC allowing  
Merrill, Morgan, Goldman, and others to use 30:1 leverage on the  
securities they sold.  Nor do they say anything about the Bushies  
doing nothing about the speculative bubble in oil futures (explained  
in Michael Masters' Senate testimony), which fueled a rise in other  
commodity futures to ridiculous levels (wheat at $25/bushel???).

The Dems, on the other hand, never mention Clinton going along with  
getting rid of Glass-Steagal (which prevented banks from acting like  
investment houses) nor the Democrats' participation in exempting  
Credit Default Swaps from being regulated.

The Fairfax County, Virginia, Employee Pension Fund was reported to  
have lost $10 million when Lehman went bankrupt.  That's one pension  
fund, in one investment.  I shudder to think of the total hit to  
pension funds.

In one sentence, Fed Chairman Bernanke lays out what the real problem  
was.  He doesn't use the specific words, but it was a failure to  
regulate the items he mentioned  (which I have highlighted in bold  
face).  e.g., There may have been four times as much insurance written  
on Lehman Brothers bonds as there were bonds.  AIG may have been the  
biggest insurer.  Who's going to have to pay up?  Will it be you and  
me?  Bernanke says creditors will suffer; sure, sure, we'll tell the  
Chinese and others to screw off.  Stay tuned.

I left in much of what he said about the solutions, as this is the  
best and most current summary I've seen, and underlined and b.f'd a  
few things that might make it clear to some deniers that we shouldn't  
expect the taxpayers to recoup the cost of this, at least in terms of  
the trillion plus that's going to be spent.  Taxpayers are now going  
to sponsor further consolidation (and therefore reduction in  
competition) of the financial industry.

Marty


http://www.streetinsider.com/General+News/Full+Text+from+Bernankes+Speech+to+Economic+Club+of+New+York+1015/4069148.html
Bernanke's Speech to Economic Club of New York

October 15, 2008 12:24 PM EDT

--snip--
The crisis we face in the financial markets has many novel aspects,  
largely arising from the complexity and sophistication of today's  
financial institutions and instruments and the remarkable degree of  
global financial integration that allows financial shocks to be  
transmitted around the world at the speed of light. --snip--

This financial crisis has been with us for more than a year. It was  
sparked by the end of the U.S. housing boom, which revealed the  
weaknesses and excesses that had occurred in subprime mortgage  
lending. However, as subsequent events have demonstrated, the problem  
was much broader than subprime lending. Large inflows of capital into  
the United States and other countries stimulated a reaching for yield,  
an underpricing of risk, excessive leverage, and the development of  
complex and opaque financial instruments that seemed to work well  
during the credit boom but have been shown to be fragile under stress.  
The unwinding of these developments, including a sharp deleveraging  
and a headlong retreat from credit risk, led to highly strained  
conditions in financial markets and a tightening of credit that has  
hamstrung economic growth.

--snip--

Notwithstanding our efforts and those of other policymakers, the  
financial crisis intensified over the summer as mortgage-related  
assets deteriorated further, economic growth slowed, and uncertainty  
about the financial and economic outlook increased. As investors and  
creditors lost confidence in the ability of certain firms to meet  
their obligations, their access to capital markets as well as to short- 
term funding markets became increasingly impaired, and their stock  
prices fell sharply. Prominent companies that experienced this dynamic  
most acutely included the government-sponsored enterprises (GSEs)  
Fannie Mae and Freddie Mac, the investment bank Lehman Brothers, and  
the insurance company American International Group (AIG).

--snip--
To avoid unacceptably large dislocations in the mortgage markets, the  
financial sector, and the economy as a whole, the Federal Housing  
Finance Agency put Fannie and Freddie into conservatorship, and the  
Treasury, drawing on authorities recently granted by the Congress,  
made financial support available. The government's actions appear to  
have stabilized the GSEs, although, like virtually all other firms,  
they are experiencing effects of the current crisis. We have already  
seen benefits of their stabilization in the form of lower mortgage  
rates, which will help the housing market.

The difficulties at Lehman and AIG raised different issues. Like the  
GSEs, both companies were large, complex, and deeply embedded in our  
financial system. In both cases, the Treasury and the Federal Reserve  
sought private-sector solutions, but none was forthcoming. A public- 
sector solution for Lehman proved infeasible, as the firm could not  
post sufficient collateral to provide reasonable assurance that a loan  
from the Federal Reserve would be repaid, and the Treasury did not  
have the authority to absorb billions of dollars of expected losses to  
facilitate Lehman's acquisition by another firm. Consequently, little  
could be done except to attempt to ameliorate the effects of Lehman's  
failure on the financial system. Importantly, the financial rescue  
legislation, which I will discuss later, will give us better choices.  
In the future, the Treasury will have greater resources available to  
prevent the failure of a financial institution when such a failure  
would pose unacceptable risks to the financial system as a whole. The  
Federal Reserve will work closely and actively with the Treasury and  
other authorities to minimize systemic risk.

In the case of AIG, the Federal Reserve and the Treasury judged that a  
disorderly failure would have severely threatened global financial  
stability and the performance of the U.S. economy. We also judged that  
emergency Federal Reserve credit to AIG would be adequately secured by  
AIG's assets. To protect U.S. taxpayers and to mitigate the  
possibility that lending to AIG would encourage inappropriate risk- 
taking by financial firms in the future, the Federal Reserve ensured  
that the terms of the credit extended to AIG imposed significant costs  
and constraints on the firm's owners, managers, and creditors.

AIG's difficulties and Lehman's failure, along with growing concerns  
about the U.S. economy and other economies, contributed to  
extraordinarily turbulent conditions in global financial markets in  
recent weeks. Equity prices fell sharply. Withdrawals from prime money  
market mutual funds led them to reduce their holdings of commercial  
paper--an important source of financing for the nation's nonfinancial  
businesses as well as for many financial firms. The cost of short-term  
credit, where such credit has been available, jumped for virtually all  
firms, and liquidity dried up in many markets. By restricting flows of  
credit to households, businesses, and state and local governments, the  
turmoil in financial markets and the funding pressures on financial  
firms pose a significant threat to economic growth.

The Treasury and the Fed have taken a range of actions to address  
financial problems. To address illiquidity and impaired functioning in  
commercial paper markets, the Treasury implemented a temporary  
guarantee program for balances held in money market mutual funds to  
help stem the outflows from these funds. The Federal Reserve put in  
place a temporary lending facility that provides financing for banks  
to purchase high-quality asset-backed commercial paper from money  
market funds, thus reducing their need to sell the commercial paper  
into already distressed markets. Moreover, we soon will implement a  
new, temporary Commercial Paper Funding Facility that will provide a  
backstop to commercial paper markets by purchasing highly rated  
commercial paper directly from issuers at a term of three months when  
those markets are illiquid.

To address ongoing problems in interbank funding markets, the Federal  
Reserve has significantly increased the quantity of term funds it  
auctions to banks and accommodated heightened demands for temporary  
funding from banks and primary dealers. Also, to try to mitigate  
dollar funding pressures worldwide, we have greatly expanded  
reciprocal currency arrangements (so-called swap agreements) with  
other central banks. Indeed, this week we agreed to extend unlimited  
dollar funding to the European Central Bank, the Bank of England, the  
Bank of Japan, and the Swiss National Bank. These agreements enable  
foreign central banks to provide dollars to financial institutions in  
their jurisdictions, which helps improve the functioning of dollar  
funding markets globally and relieve pressures on U.S. funding  
markets. It bears noting that these arrangements carry no risk to the  
U.S. taxpayer, as our loans are to the foreign central banks  
themselves, who take responsibility for the extension of dollar credit  
within their jurisdictions.

The expansion of Federal Reserve lending is helping financial firms  
cope with reduced access to their usual sources of funding and thus is  
supporting their lending to nonfinancial firms and households.  
Nonetheless, the intensification of the financial crisis over the past  
month or so made clear that a more powerful, comprehensive approach  
involving the fiscal authorities was needed to address these problems  
more effectively. On that basis, the Administration, with the support  
of the Federal Reserve, asked the Congress for a new program aimed at  
stabilizing our financial markets. The resulting legislation, the  
Emergency Economic Stabilization Act, provides important new tools for  
addressing the distress in financial markets and thus mitigating the  
risks to the economy. The act allows Treasury to buy troubled assets,  
to provide guarantees, and to inject capital to strengthen the balance  
sheets of financial institutions. The act also raises the limit on  
deposit insurance from $100,000 to $250,000 per account, effectively  
immediately.

The Troubled Asset Relief Program (TARP) authorized by the legislation  
will allow the Treasury, under the supervision of an oversight board  
that I will head, to undertake two highly complementary activities.  
First, the Treasury will use the TARP funds to help recapitalize our  
banking system by purchasing non-voting equity in financial  
institutions. Details of this program were announced yesterday.  
Initially, the Treasury will dedicate $250 billion toward purchases of  
preferred shares in banks and thrifts of all sizes. The program is  
voluntary and designed both to encourage participation by healthy  
institutions and to make it attractive for private capital to come in  
along with public capital. We look to strong institutions to  
participate in this capital program, because today even strong  
institutions are reluctant to expand their balance sheets to extend  
credit; with fresh capital, that constraint will be eased. The terms  
offered under the TARP include the acquisition by the Treasury of  
warrants to ensure that taxpayers receive a share of the upside as the  
financial system recovers. Moreover, as required by the legislation,  
institutions that receive capital will have to meet certain standards  
regarding executive compensation practices.

Second, the Treasury will use some of the resources provided under the  
bill to purchase troubled assets from banks and other financial  
institutions, in most cases using market-based mechanisms. Mortgage- 
related assets, including mortgage-backed securities and whole loans,  
will be the focus of the program, although the law permits flexibility  
in the types of assets purchased as needed to promote financial  
stability. Removing these assets from private balance sheets should  
increase and liquidity and promote price discovery in the markets for  
these assets, thereby reducing investor uncertainty about the current  
value and prospects of financial institutions. Unclogging the markets  
for mortgage-related assets should put banks and other institutions in  
a better position to raise capital from the private sector and  
increase the willingness of counterparties to engage. With time, the  
provision of equity capital to the banking system and the purchase of  
troubled assets will help credit flow more freely, thus supporting  
economic growth.

These measures will lead to a much stronger financial system over  
time, but steps are also necessary to address the immediate problem of  
lack of trust and confidence. Accordingly, also announced yesterday  
was a plan by the Federal Deposit Insurance Corporation (FDIC) to  
provide a broad range of guarantees of the liabilities of FDIC-insured  
depository institutions, including their associated holding companies.  
The guarantee covers all newly issued senior unsecured debt, including  
commercial paper and interbank funding, and it will also cover all  
funds held in non-interest-bearing transactions accounts, such as  
payroll accounts. This broad guarantee will be effectively  
immediately, and fees for coverage will be waived for 30 days. After  
the 30-day grace period, banks may continue to participate in the  
guarantee program by paying reasonable fees.

I would like to stress once again that the taxpayers' interests were  
very much in our minds and those of the Congress when these programs  
were designed. The costs of the FDIC guarantee are expected to be  
covered by fees and assessments on the banking system, not by the  
taxpayer. In the case of the TARP program, the funds allocated are not  
simple expenditures, but rather acquisitions of assets or equity  
positions, which the Treasury will be able to sell or redeem down the  
road. Indeed, it is possible that taxpayers could turn a profit from  
the program, although, given the great uncertainties, no assurances  
can be provided. Moreover, the program is subject to extensive  
controls and to oversight by several bodies. The larger point, though,  
is that the economic benefit of these programs to taxpayers will not  
be determined primarily by the financial return to TARP funds, but  
rather by the impact of the program on the financial markets and the  
economy. If the TARP, together with the other measures that have been  
taken, is successful in promoting financial stability and,  
consequently, in supporting stronger economic growth and job creation,  
it will have proved itself a very good investment indeed, to  
everyone's benefit.

Stabilization of the financial markets is a critical first step, but  
even if they stabilize as we hope they will, broader economic recovery  
will not happen right away. --snip--  Ultimately, the trajectory of  
economic activity beyond the next few quarters will depend greatly on  
the extent to which financial and credit markets return to more normal  
functioning.

Inflation has been elevated recently, reflecting the steep increases  
in the prices of oil, other commodities, and imports that occurred  
earlier this year, --snip--

Americans can be confident that every resource is being brought to  
bear to address the current crisis: historical understanding,  
technical expertise, economic analysis, financial insight, and  
political leadership. I am not suggesting the way forward will be  
easy, but I strongly believe that we now have the tools we need to  
respond with the necessary force to these challenges. Although much  
work remains and more difficulties surely lie ahead, I remain  
confident that the American economy, with its great intrinsic vitality  
and aided by the measures now available, will emerge from this period  
with renewed vigor.




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