Ruh-Roh

(Photo: Dimitri Dilkoff - Getty Images; NYT Online)

From today's New York Times Online:

“Greece may just be an early warning signal,” said Byron Wien, a prominent Wall Street strategist who is vice chairman of Blackstone Advisory Partners. “The U.S. is a long way from being where Greece is, but the developed world has been living beyond its means and is now being called to account.”

In the struggle to pass legislation in Congress to strengthen regulation of our barely-controlled financial sector, one amendment has been offered that would call for an audit of the Federal Reserve Bank. This has been resisted, strongly, by both Treasury Secretary Geithner (Timmeh!), and (Surprise!) the White House.

The current Greek/European debt crisis has a direct bearing on why Timmeh and the White House are fighting tooth and nail to prevent such an audit, and why we should be more worried, and pay more attention to what's happening with Europe's financials, than we are.

As an ex-DOJ and Financial Analyst Dog, resisting any move for more transparency generally means there's something to hide -- and while that's only my opinion and not fact, I think it may be a common one: There's a great deal that's rotten in our financial system, and it's all being hidden from view so that we don't run screaming off a cliff.

John Talbot noted in an article in Salon that the American financial crisis was hidden, but not cured, by our government's response to the crisis. If you haven't read it, you should.

Talbot noted that Troubled Asset Protection Plan (or, TARP) funds made available by the Bush administration to shore up banks and investment houses weren't used that way. Then-Treasury Secretary (and former Goldman-Sachs' CEO) Hank Paulson convinced Congress over a weekend that he needed $700 billion of TARP funds to purchase toxic assets held by America's commercial banks.

Within weeks of being given the funds by Congress, Paulson decided not to do this -- instead, he gave hundreds of billions of dollars directly to the commercial and investment banks to do what they wanted with it, and to fund a series of bailouts: Money to Chrysler and General Motors, and the Insurer AIG -- much of which immediately found its way back to the commercial and investment banks who were already getting huge amounts of government money.

To cut to the chase as Talbot reports it (increasing the number of paragraphs for emphasis is mine),

At the time [2008], nobody explained what happened to the toxic assets on the banks' books whose purchase was the original stated purpose of TARP.

We now know that the financial crisis was not caused solely by a liquidity crunch or an irrational loss of confidence, but rather by the fact that the marketplace realized that the commercial banks held more than a trillion dollars of very poor-quality ... mortgage securities such as collateralized debt obligations, or CDO’s, and that these bad assets were sizable enough to bankrupt even our biggest banks.

How bad? Even the AAA [valued] CDO is facing a mortgage default rate of approximately 93 percent today.

Talbot goes on to say that the reason Paulson didn’t pursue the original plan for the government to purchase these toxic assets is because such a purchase would have created a market price for them.

Suddenly, the banks would have had to "mark-to-market" -- to acknowledge that the CDO's they had invested in, sold to them by other fellow-players like Lehman and Goldman-Sachs, were worth a fraction of what was paid for them. Nearly all of our major commercial and investment banks would have had to declare bankruptcy.

You can see why this couldn't be allowed to happen.

What I believe the Fed did next [Talbot continues] was fraudulent and deceitful, its full impact still hidden from the American public, who want bank reform.

The Fed, I am convinced, went to these commercial banks and offered to take many of their toxic mortgage assets off their books, often accepting them as collateral for loans to the banks...

So the Federal Reserve, with no approval by the president, the Congress, the people or their elected representatives, ended up purchasing $1.5 trillion of new assets of unknown quality... What concerns many knowledgeable investors is that the Fed doesn't have the money needed to purchase these assets and instead prints new money.

As of March 2010, there was approximately $1 trillion of currency outstanding in the country, not including the more than $1 trillion of bank reserves at the Fed. So if the Fed doesn't shrink its balance sheet, we can expect inflation to come roaring back as banks increase lending in the future.

This $1.5-Trillion-dollar debt is being kept "off the books" -- an allowable but in these circumstances near-criminal accounting activity, and hidden only by the amount of physical cash the Fed directs the U.S. Mint to print and put in circulation.

As if I had to say anything, Paulson's decisions (supported by Fed Chairman Bernanke and America's major banks) only forestalled the potential reckoning of $1.5T in bad debt. It also hides the fact of that debt from the American population.


(Chart: Calculated Risk)

The direct exposure of American banks to Greece is small [notes the New York Times article],but below the surface, there are signs of other fissures. Even the strongest banks in Germany and France have heavy exposure to more troubled economies on the periphery of the Continent, and these big banks in turn are closely intertwined with their American counterparts.

Over all, United States banks have $3.6 trillion in exposure to European banks, according to the Bank for International Settlements. That includes more than a trillion dollars in loans to France and Germany, and nearly $200 billion to Spain.

What’s more, American money-market investors are already feeling nervous about hundreds of billions of dollars in short-term loans to big European banks and other financial institutions... With so much uncertainty about Europe and its common currency, the euro, managers of these ultra-safe investment vehicles are demanding that European borrowers pay higher rates.

These funds provide the lifeblood of the international banking system. If worries about the safety of European banks intensify, it could push up their borrowing costs and push down the value of more than $500 billion in short-term debt held by American money-market funds...

Now, as Europe teeters, the dangers to the American economy — and the broader financial system — are becoming increasingly evident.

Gosh. A trillion here; a trillion there; pretty soon, it adds up to real money. I live paycheck to paycheck, and a thousand dollars is a serious amount to me. But, then, I'm just one of the Peasants our Masters Of The Universe are so proud to live above.

This weekend is critical -- one attempt to create a loan package for the Greeks last week did nothing to calm fears of a larger collapse; the plummeting of world financial markets (pushed further in the case of the Dow by automatic trading software) on Thursday was the result. Whatever fix can be created will have to both offer a hopeful solution and be accepted by the Greeks, and neither is certain.

No matter how smart I may be, I don't pretend to understand every nuance of a system that's been made intentionally opaque, in order to allow the kind of behavior that created this crisis. But it doesn't take a PhD in Economics to perceive that a serious ripple in the world financial system -- one that starts in Greece, say, or Portugal and Spain's economies -- might set in motion an interlocked series of banking / investment / stock market collapses that could make the Great Depression look like a one-day-drop in the Dow.

Ruh-Roh.

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