Far I hear a steady drummer,As the Asian stock markets begin to open on Monday, August 8th, people will have some sense of how institutional and private investors are gauging the downgrade of America's Treasury bonds by the ratings agency, Standard & Poors, from the highest tier of safety (AAA) to one step below (AA-plus).
drumming like a noise in dreams...
--A. E. Houseman (1896)
Paul Brodsky, an investment advisor in QB Partners in New York, issued this warning to its clients about the S&P move (via The Big Picture):
Although S&P is careful to point out that a downgrade of government obligations does not imply risk among all [American businesses and corporations], we believe this sovereign credit downgrade does imply increasing risk for all US dollar-denominated financial assets.What Brodsky means is that the money used to repay our creditors may be tied to an economy which might fail if not fixed -- that the U.S. dollar may not be stable.
Implicit in S&P’s downgrade is the growing likelihood that the Fed will have to manufacture sufficient base money with which systemic debt can be repaid. (Currently the ratio of [U.S. Treasury Bonds to U.S. currency in circulation] is 26:1.)
Thus, the downgrade is effectively a currency downgrade, which seems very reasonable, overdue and, in real terms, insufficient. We would argue that in real terms, US Treasury obligations are non investment-grade... [they are] today and always will be money-good, but principal and interest [on purchase of Treasury securities] will be repaid with bad money.
The general expectation seems to be that when the American Markets open tomorrow morning, the sell-off could be immediate and brutal. The Markets have built-in 'Halt' triggers -- when the DJIA declines 10% at any time before 11:00AM PDST, the market will cease operations for an hour and then resume. If it declines 20% at any time before 10:00AM PDST, the markets will stop for thirty minutes, then restart. If the DJIA drops Thirty Per Cent at any time, trading is suspended for the remainder of the day.
Just so you know.
The NYT reports that members of the global financial community conducted dial-in meetings yesterday, and continued them today to find "a way to respond to market tensions that seemed to be growing too powerful for any one economic superpower to cope with alone."
“They just can’t allow the Italian economy to go down the tubes. It would be a Lehman-type situation,” Uri Dadush, a senior associate at the Carnegie Endowment for International Peace, said Sunday... referring to the collapse of the investment bank Lehman Brothers in 2008, which touched off the global financial crisis.Down here, to people the street, a drop of nearly 2,000 points in the Dow Jones Industrial Average (DJI) over the past few weeks is... well, it's just not real news. Even the Standard & Poors downgrade of United States sovereign debt (bonds) from Triple-A to AA+ -- so; what? And the European thing; hey, what's that mean to me?
Mr. Dadush put the cost of a bailout of Italy at $1.4 trillion, with Spain requiring another $700 billion. Those amounts would be a challenge even for the most solvent European countries, foremost among them Germany... Finance ministers of the Group of 7 and Group of 20 nations were conferring Sunday, Reuters reported...
“I don’t know if there is a policy response that makes sense, except support the banks,” Carl B. Weinberg, chief economist of High Frequency Economics in Valhalla, N.Y., said Sunday. He said the European Central Bank, which has already expanded its cheap loans to banks, should make even greater sums available so institutions could survive a decline in the value of their holdings of Spanish and Italian debt.
Quite a bit. This is a very simplistic set of explanations:
- The Economies Of The G-7 and G-20 Nations Are Interconnected By Debt.
Banks and financial centers always do business with each other, and the host governments in the countries where they're based -- the U.S., Germany, Britain, France, Japan; etc. Even in 'Good Times', problems with the banks in one country can upset an interconnected global financial structure -- but in times of relative stability, there's more flexibility in that structure if a single bank goes under.
Since 1998 in America, banks have been allowed to trade and sell securities in addition to their traditional function as issuers of loans to consumers -- and during the "Go-Go", "Lil' Boots" Bush years, America's banks and trading firms produced financial instruments, revolving around the worldwide Real Estate Bubble
Most of these obligations are interconnected -- Mortgage loans issued to borrowers by banks; pools of mortgages creating securities (Colateralized Debt Obligations), sold to individual investors, but primarily to institutions (such as Pension Funds, or Hedge Funds); and, Credit-Default Swaps, a sophisticated way of betting on the success or failure of those CDO's, or specific investment portfolios. - The Debt Was Based In Real Estate Lending.
All this was a model born in the U.S. (most spectacularly by Countrywide Financial, the Enron of mortgage lenders). Home loans were almost given away -- the terms were absurd; no-down; interest-only payments; adjustable rates that the new homeowners couldn't afford after they reset.
The financial system encouraged this this activity, which was nothing more than speculation. It helped that our own Central Bank -- the Federal Reserve -- was chaired by Alan Greenspan, who touted these new CDO financial instruments and encouraged speculative lending. The U.S. Treasury (through its Secretary, former Goldman CEO Hank Paulson) lowered interest rates on government lending to banks, at a time when the Treasury was losing revenue due to the Lil' Boots Bush Forever Tax Cuts. The idea of risk, of 'moral hazard', was discarded and kicked to the curb.
Everyone on the gravy train -- the mortgage lenders; the banks and investment houses; salespeople and executives, wanted people to believe that the Casino would never close and there would be a happy ending and a Magic Pony for everyone -- because we were Americans, and special. History and the laws of economics were for losers, or foreigners.
Homes were being purchased and quickly refinanced for cash to support "Good Times" lifestyles -- people bought cars, appliances, vacations, clothes and technology. The economy expanded to support all that -- but it was all based on debt. Property values increased; so did the price of property and the sizes of the loans people applied for and received. Additional properties were being purchased for investment by people who couldn't really afford to repay the loans on their primary residences.
In just six years, between 2001 and 2007, our banks and securities firms became incredibly successful... on paper. And, with the "Lil' Boots" Bush tax cuts for the wealthiest, while salaries and wages remained flat for everyone else, those with cash to invest and play were doing the best of all. And the rest of us who weren't getting raises? Hell; we'll just refinance the home-place! Now we can live just like the rich! Good Times. - The Interconnected Debt From The Bubble Of Speculation Is Worldwide.
This Made-In-USA Kool-aid was drunk in much of the EU (though Germany seems not to have been infected with Teh Stupid, so much; Gott Sei Dank), but in Ireland, in Spain, in Britain... they couldn't build new homes and sell them fast enough. And the banks in America did business with banks in Europe, of course. It was a worldwide, shark-tank feeding frenzy, and nearly every major bank and financial house around the globe was involved. Everyone wanted their Magic Pony.
No official estimate of all this debt, worldwide, has been released, but I have seen someone's figure recently (and can't now find the reference to link it to; sorry) of approximately $130 Trillion US -- an ocean of debt, held back by a dam made of paper, and magic ponies; 'champagne wishes, and caviar dreams'. - The Response Of Governments To The 2008 Collapse Was To Give Money To The Banks.
The executives and managers of these companies, and their shareholders, were kept safe from loss. This also kept investors big and small around the globe from a panic selling of every stock they held and having another series of days like October 29, 1929. So they handed money to Goldman-Sachs and BankAmerica and AIG and the rest of them -- all of whom had helped to create the crisis.
It was, at least in my opinion, like handing money to a bunch of rapists while their victim was still on the ground, and the Boyz were zipping up their pants. They took the money, and smiled; We'll take it -- and, we're not goin' to jail for this; capiche?
While this kept the global financial system afloat, it meant that private businesses were bailed out by governments. You can describe this as turning private debt into public debt, but the most simplistic explanation is that the losses of a majority of financial institutions in the EU and America will now be paid by the citizens in those countries. You, me; the Greeks; the Irish; the Italians and the British; etc.
The only ones who received A Magic Pony and a Get Out Of Jail Free card were the Banks. The rest of us... well, you know about that. - The Countries Who Gave Public Money To Save Their Banksters Are Now Themselves In Trouble.
This is where it gets sticky.
The mortgage loans (used to create 'pools' that could be invested in through CDO securities) weren't worth what banks, or businesses like Countrywide, which issued them said they were. And in the aftermath of the Crash of 2008, financial firms had gobbled up the bad loans of their other, failed brothers through acquisition, and now owned the bad loans, and the overvalued CDO securities, of the companies they'd absorbed.
But if the banks and investment houses admitted the value of what they held was a sham, they would lose more money. Their publicly-traded shares would lose value, and they might eventually fail themselves.
They didn't bother to tell the governments who were giving them money any of this, though the politicians surely knew; there were analysts on both sides of the ocean and investment strategists who had known it, and warned about the dangers in the Speculation Bubble, for years.
What the Banks didn't say, can't say, is that there isn't enough money in the U.S. Treasury to cover all the debt they have on their books. And the same is true for most governments in the EU.
This story is being played out around the world. EU governments have no choice but to try and loan more and more money to governments, who are failing because they've poured out billions of Euros to 'save' their banks. Meanwhile, their economies have shrunk -- meaning unemployment and loss of tax revenue, and those governments continue to run deficits against their national budgets just to meet their internal obligations.
And, they have to be able to make payments on the loans they've already received from the ECB. Eventually, they will have to pay holders of their government's treasury bonds when they mature. And Greek bonds are trading at interest rates of over 15 per cent; Irish bonds at 11%; Spanish bonds at over 5%, and the list goes on.
In the quote from the NYT at the top of this post, economist Weinberg spoke for many in the financial community when he said, “I don’t know if there is a policy response that makes sense, except support the banks.” The Wise Ones who are supposed to keep a worldwide financial system from imploding feel they have no choice but to keep propping up financial institutions who made bad decisions and can't cover the black hole of debt on their books. This is all that the governments, the European Central Bank and the Federal Reserve, have in their toolkits, support for Zombie Banks -- and Austerity for their citizens.
The only way the affected governments can survive (they believe) is to cut their spending -- to curb or eliminate social programs (such as Social Security or Medicare here in the U.S.), institute voluntary Austerity; even the sale of "national assets".
All of which will directly affect the standard of living of their citizens, who are angry at being told they have to live with less because the banks were greedy and rapacious, and their governments made the bank's debt their responsibility to pay back. It's effectively the end of a middle class in may countries around the world, including our own.
It's a Robber Barons' dream come true, a penalty-free chance to rig the markets with a Ponzi scheme and risk their shareholders' investments; run the global economy onto the rocks; then get paid by their governments to stay in business, and come out of it all amazingly rich. Meanwhile, others...
I'd say it's a recipe for revolution, in some countries; but I'm only a Dog and no one listens to me. The political ramifications of all this have yet to be felt, and none of it will be pretty. In fact, it will be (to paraphrase Paul Krugman) the worst aspects of the Depression and the McCarthy Era; "unimaginably ugly".
Now, the United States has been put on debt suicide watch by a ratings agency -- "Tough Love". If enough 'animal spirits' build up in the global Markets, they could plummet in panic selling. Within months, businesses would lay off more employees; demand for products and services would sink; unemployment would rise above 9 or even 10%. We all end up living in Yurts and watching our children play with broken iPods and toys made of animal dung.
All except for the wealthy, aber natürlich. They'll be selling us the broken iPods and animal-dung toys.
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