* David Hirst
* June 25, 2008
US banking won't survive in its current shape and its death will be painful.
DEATH is God's quiet way of saying slow down. Something more powerful than God, the US banking system, has been tapped on the shoulder and the Flaming Star flames no more. This will affect us all, but before we race to withdraw our deposits, or call super funds, or before we panic as great and powerful financial institutions far away fall, consider that most of the terrors in store are not matters that will bring National Australia Bank, ANZ, Commonwealth Bank or Westpac, or most of our pillars of finance, down.
The great fall that will soon be upon us, and has already seen US financial powerhouses such as Bear Stearns fade away, is part of the evolution of the species, a manifestation of a great purge desperately needed.
The endgame, which is still a way off, will see a card game of credit brought down. We will all be poorer in that instant, but richer in what might be a long, long time.
The US banking system as it exists now will not survive and its death throes will be painful. Details of its demise are in evidence everywhere you look. The fall of Bear Stearns, the collapse of Lehman Brothers and rumours circling the future of market super-heavyweight Goldman Sachs and Merrill Lynch attest to the end of the broker-dealer form of banking that cannot survive without securitisation, a system essentially built on kickbacks, big bonuses and the movement of money dressed up as industry.
Increasingly, people are wondering what these companies do (or did), other than pass around paper and pocket vast sums. Could they have been engaged in a massive heist dressed up in complicated terminology signifying nothing?
How can companies such as Bear Stearns, worth more than $US70 a single share, be found to be insolvent and worthless?
The shotgun marriage between Bank of America and Countrywide may be the next cause of a fresh banking crisis as it is the most obvious source of immediate, mutually assured destruction.
S&P's decision late on Friday to downgrade both banks may destroy the plan to allow Bank of America to swallow Countrywide and its almost unfathomable debt. If that doesn't concentrate the minds of the global financial community, there is plenty else to look forward to.
The death throes are evident wherever one looks within the entrails of the US financial system and it is not hard to find experts ready and raring to call the last act. George Soros, interviewed in The Wall Street Journal at the weekend, put it plainly enough. The US, he explained, has ridden out credit crisis after crisis by creating fresh bubbles, all on debt, or credit. The last bubble, the lunacy from a wider moonbeam, was what we now call subprime. In a better world, subprime would have been an excellent idea. The provision of trillions of dollars to people with no credit record, no jobs and no prospects of ever paying off their fantastically inflated home prices was a socialist dream. But it was also unbelievably improper to attempt to recharge a system built on bubbles and credit.
US banking, as it has evolved, is now passing from a deep Darwinist phase, the survival of the fittest, or the cannibalisation of the weakest, to something more explosive.
Christopher Whalen, of Institutional Risk Analytics, sees the US banking system as rather like a poisoned aquarium, where some of the fish are dying and others, like Goldman Sachs, are feasting. But the system is poisoned. "They (companies like Goldman) are very adept at staying afloat by pushing their colleagues back into the water," he says.
Perhaps, inevitably, he compares them with dinosaurs: "When the volcano erupts, all the dinosaurs will die." But he adds: "They are very nimble. The buy-side investor is withdrawing from the Bear Stearns, Lehman and Goldman Sachs crowd and fleeing to the apparent safety of the universal banks. A fool's gambit, but what else shall they do?" Regardless of daily swings in the financials, Whalen, whose associates are in that poisoned aquarium, believes the inhabitants are doomed.
The US, like all of us, conditioned itself to believe in economic cycles and the inevitable bounce. But each correction has seen the creation of a new and less stable bubble. On this fact, several authorities are now coming to the same conclusion.
One is Michael Hudson, a financial authority and adviser to numerous governments, including the US.
"The idea," he says, "that we're even in a business cycle is whistling in the dark. If we're in a cycle, then that implies there's an automatic recovery in store.
"This happy free-market idea was developed at the National Bureau of Economic Research by opponents of government regulatory policy. But the economy doesn't move by a sine curve. There is a slow build-up, and a sudden plunge, so the shape is ratchet-shaped. This is why 19th century writers didn't speak of economic cycles, but rather of periodic financial crises."
At the heart of the crisis is housing. Reports published late last week indicate a 50% fall in mortgage values in the worst area of the US. And as Hudson points out: "Today's plunging real estate and stockmarket prices are not a self-correcting ebb and flow in which downturns set in motion automatic stabilisers that produce recovery.
"When a bubble bursts, time makes things worse. The financial sector has been living in the short run for quite a while now, and I suspect that a lot of money managers are planning to get out, or be fired, now that the game is over. And it really is over.
"The Treasury's attempt to reflate the real estate market has not worked, and it can't work … The banks are trying to win back their losses by arbitrage operations, borrowing from the Fed at a low interest rate and lending at a higher one, and gambling on options.
"But options and derivatives are a zero-sum game: one party's gain is another's loss. So the banks collectively are simply painting themselves into a deeper corner.
"They hope they can tell the Fed and Treasury to keep bailing them out or else they'll fail and cost the FDIC (Federal Deposit Insurance Corporation) even more money to make good on insuring the 'bad savings' that have been steered into these bad debts and bad gambles."
But even the Fed has its limits, having spent more than half its almost trillion-dollar balance sheet buying junk securities to leave sound Treasury securities on the banking system's balance sheets.
Like many others, Hudson believes many small regional banks will go under and be merged into larger money-centre banks — just as many brokerage firms in recent decades have been merged into larger conglomerates. "False reporting also will help financial institutions avoid the appearance of insolvency," he says.
Increasingly, independent analysts like Whalen and Hudson are blaming deregulation, especially the repeal of the 1930s Glass-Steagall Act that was passed to prevent a recurrence of the practices and results we are seeing today, and repealed by Bill Clinton, leading, as Hudson observed, to insufficient, or non-existent, oversight.
The hard hand of the regulator must be evident and constant. In these difficult days, we look to a new leader to emerge, for that is democracy's birthright and its meaning.
For anyone wishing to understand these issues more thoroughly, Planet Wall Street recommends they consult the Institutional Risk Analytics site. It costs nothing and explains these issues in detail and with authority.
David Hirst is a journalist, documentary maker, financial consultant and investor. His column, Planet Wall Street, is syndicated by News Bites, a Melbourne-based sharemarket and business news publisher.
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