All this happened at the end of eight straight years that America devoted to frantically chasing the shadow of a terrorist threat to no avail, eight years spent stopping every citizen at every airport to search every purse, bag, crotch and briefcase for juice boxes and explosive tubes of toothpaste. Yet in the end, our government had no mechanism for searching the balance sheets of companies that held life-or-death power over our society and was unable to spot holes in the national economy the size of Libya (whose entire GDP last year was smaller than AIG's 2008 losses).So it's time to admit it: We're fools, protagonists in a kind of gruesome comedy about the marriage of greed and stupidity.Matt Taibi ,Rolling Stone

DERIVATIVES

$596 Trillion!

How can the derivatives market be worth more than the world's total financial assets?

By Jacob Leibenluft

Posted Wednesday, Oct. 15, 2008, at 4:18 PM ET

Traders at the New York Stock ExchangeIowa Sen. Tom Harkin issued a call on Tuesday for regulation of the "over the counter" derivatives market, which has an estimated size of about $596 trillion. By contrast, the value of the world's financial assets—including all stock, bonds, and bank deposits—was pegged at $167 trillion last year by McKinsey. How can the derivatives market be larger than the entire world's financial wealth?

Because the same assets might be involved in several different derivatives. A derivative is a financial instrument whose value depends on something else—a share of stock, an interest rate, a foreign currency, or a barrel of oil, for example. One kind of derivative might be a contract that allows you to buy oil at a given price six months from now. But since we don't yet know how the price of oil will change, the value of that contract can be very hard to estimate. (In contrast, it's relatively easy to add together the value of every share being traded on the stock market.)

In The Big Money, Dan Weil discussed what might happen with the derivatives market. In 2003, Daniel Gross asked whether "derivatives will kill us or make us stronger." Three years later, Gross discussed the future of stock markets in an age of derivatives. As a result, financial experts have to make an educated guess about the total amount at stake in all these contracts. One method simply adds up the value of the assets the derivatives are based on. In other words, if my contract allows me to buy 50 barrels of oil and the current price is $100, its "notional value" is said to be $5,000—since that's the value of the assets from which my contract derives. If you make that same calculation for every derivative and add those numbers together, you get something around $596 trillion—the "notional value" of the world's over-the-counter derivatives at the end of 2007, according to the Bank of International Settlements. ("Over the counter" derivatives refer to contracts that are negotiated between two parties rather than through an exchange.)

But the "notional value" isn't usually a very good representation of what a contract might really be worth to the parties involved, or how much risk they are taking. (And it isn't easily compared with other measures of financial wealth—after all, owning the right to buy $5,000 worth of oil isn't the same as actually owning $5,000 of oil.) Within that $596 trillion are derivatives that effectively relate to the same assets—if you have a contract to buy euros in January and I have one to buy euros in April, we may end up buying the same currency, but its notional value will get counted twice. Moreover, in many instances, the "notional amount" is just a benchmark that never even changes hands—as in the case of the interest-rate swap, by far the most common type of derivative. Likewise, because derivatives are often used to hedge risks, there's a good probability that many contracts in the system essentially cancel one another out.

An alternative way to measure the size of the derivatives market is to calculate the instruments' market value—which refers to how much they would be worth if the contracts had to be settled today. Gross market value of all outstanding derivatives was $14.5 trillion at the end of 2007, less than one-fortieth of the $596 trillion estimate. (That number shrinks to about $3.3 trillion once you take into account contracts that directly offset one another.)

Still, the concept of "notional value" is not entirely irrelevant. For one, growth in the notional value of all derivatives—which has gone up about fourfold in the last five years—does give a reasonable indication of how fast the market is expanding. And for credit default swaps, a derivative at the center of the current financial crisis, the growth has been especially large—with the total notional amount rising from just $2.69 trillion in 2003 to $54.6 trillion this year.

Geithner Plan Will Rob US Taxpayers

By Reuters

March 24, 2009 "Reuters" -- The U.S. government plan to rid banks of toxic assets will rob American taxpayers by exposing them to too much risk and is unlikely to work as long as the economy remains weak, Nobel Prize-winning economist Joseph Stiglitz said on Tuesday.

"The Geithner plan is very badly flawed," Stiglitz told Reuters in an interview during a Credit Suisse Asian Investment Conference in Hong Kong.

U.S. Treasury Secretary Timothy Geithner's plan to wipe up to US$1 trillion in bad debt off banks' balance sheets, unveiled on Monday, offered "perverse incentives", Stiglitz said.

The U.S. government is basically using the taxpayer to guarantee against downside risk on the value of these assets, while giving the upside, or potential profits, to private investors, he said.

"Quite frankly, this amounts to robbery of the American people. I don't think it's going to work because I think there'll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer."

Even if the plan clears banks of massive toxic debt, worries about the economic outlook mean banks could still be unwilling to make fresh loans, while the prospect of a higher tax burden to pay for various government stimulus plans could further undermine U.S. consumers, he said.

Some Republican lawmakers have also expressed concern over the incentives offered by the government, which could end up providing private investors with more than 90 percent of the funds to buy the troubled assets.

But President Barack Obama has said the plan was critical to a U.S. economic recovery, Stiglitz, a professor at New York's Columbia University and a former World Bank chief economist, also urged G20 leaders at their London summit next month to commit to providing greater resources to developing countries and said China should be given bigger voting rights in the International Monetary Fund.

"The voices of developing countries, and countries like China that will provide a lot of the money, are not heard."

Spring Real Estate Guide 2009 | A CNBC Special Report

China would be hard pushed to reach its targeted 8 percent economic growth this year, but the important thing was that at least the Chinese economy was still growing, he said.

Stiglitz welcomed China's proposal on Monday for an overhaul of the world monetary system in which Zhou Xiaochuan, governor of the People's Bank of China, said the IMF's Special Drawing Right has the potential to become a super-sovereign reserve currency.

Stiglitz has long called for the U.S. dollar to be replaced as the only reserve currency.

Basing a reserve system on a single currency whose strength depends on confidence its own economy is not a good basis for a global system, he says.

"We may be at the beginning of a loss of confidence (in the U.S. dollar reserve system)," he said. "I think there is support for some sort of global reserve system.

Debt Relief and Regulation

By Mike Whitney

From:   Peter Myers   

http://www.globalresearch.ca/index.php?context=va&aid=12632

Information Clearing House

March 9, 2009

Geithner and Bernanke know what toxic assets are worth - Mike Whitney

"We've explained the difference between a recession and a depression before. But we'll do it again. A recession is a pause in an otherwise healthy, growing economy. A depression is when the economy drops dead." Bill Bonner, The Daily Reckoning

There's good news and bad news. The good news is that Obama's economics team understands the fundamental problem with the banks and knows what needs to be done to fix it. The bad news is that Bernanke, Summers and Geithner all have close ties to the big banks and refuse to do what's necessary. Instead, they keep propping up failing institutions with capital injections while concocting elaborate strategies for purchasing the banks bad assets through backdoor transactions. It's all very opaque, despite the cheery public relations monikers they slap on their various "rescue" plans. This charade has gone on for more than a month while unemployment has continued to soar, the stock market has continued to plunge, and the country has slipped deeper into economic quicksand.

Paul Krugman summed up the administration's response in Friday's column, "The Big Dither":

"There's a growing sense of frustration, even panic, over Mr. Obama's failure to match his words with deeds. The reality is that when it comes to dealing with the banks, the Obama administration is dithering. Policy is stuck in a holding pattern....

Why do officials keep offering plans that nobody else finds credible? Because somehow, top officials in the Obama administration and at the Federal Reserve have convinced themselves that troubled assets ... are really worth much more than anyone is actually willing to pay for them — and that if these assets were properly priced, all our troubles would go away. ...

What's more, officials seem to believe that getting toxic waste properly priced would cure the ills of all our major financial institutions.(Paul Krugman, The Big Dither, New York Times)

Krugman is right about the "dithering" but wrong about the toxic waste. Geithner and Bernanke know exactly what these assets are worth--- just pennies on the dollar. That's why Geithner has avoided taking $5 or $10 billion of these mortgage-backed securities (MBS) and putting them up for public auction. That would be the reasonable thing to do and it would remove any doubt about their true value. But the Treasury Secretary won't do that because it would just draw attention to the fact that the banking system is insolvent; the vaults are full of nothing but garbage loans that are defaulting at a record pace. Instead, Geithner has cooked up a plan for a "public-private partnership" which will provide up to $1 trillion in funding for private equity and hedge funds to purchase toxic assets from the banks. The Treasury will offer low interest "non recourse" loans (with explicit government guarantees against any potential loss) to qualified investors. If the hedge funds or private equity firms don't turn a profit in three years, they simply return the assets to the Treasury and get their money back. In essence, Geithner's plan provides a lavish subsidy to private industry on an totally risk free investment. It's a sweetheart deal.

At the same time, the plan achieves Geithner's two main objectives; it gives the banks the chance to scrub their balance sheets of junk mortgages and it also allows them to keep the present management-structure in place. The $1 trillion taxpayer giveaway to the hedge funds is just another juicy bone tossed to Geithner's real constituents-- Wall Street speculators.

Unfortunately, markets don't like uncertainty, which is why Geithner's circuitous plan has put traders in a frenzy. Wall Street has gone from scratching its head in bewilderment, to a stampede for the exits. In the last month alone, the stock market has plummeted a whopping 18 percent, indicating ebbing confidence in the political leadership. Geithner is now seen as another glorified bank lobbyist like his predecessor, Paulson, who is in way over his head. His lack of clarity has only added to the widespread sense of malaise. Markets require transparency and details, not obfuscation, gibberish and Fed-speak. This is how Baseline Scenario blogger Simon Johnson summed it up:

"Confusion helps the powerful... When there are complicated government bailout schemes, multiple exchange rates, or high inflation, it is very hard to keep track of market prices and to protect the value of firms. The result, if taken to an extreme, is looting: the collapse of banks, industrial firms, and other entities because the insiders take the money (or other valuables) and run.

This is the prospect now faced by the United States.

Treasury has made it clear that they will proceed with a "mix-and-match" strategy, as advertised....The course of policy is set. For at least the next 18 months, we know what to expect on the banking front. Now Treasury is committed, the leadership in this area will not deviate from a pro-insider policy for large banks; they are not interested in alternative approaches (I've asked). The result will be further destruction of the private credit system and more recourse to relatively nontransparent actions by the Federal Reserve, with all the risks that entails.

The road to economic hell is paved with good intentions and bad banks."(Simon Johnson Baseline Scenario)

This is unusually harsh criticism from a former head economist at the IMF, but Johnson's analysis is dead-on. Geithner is putting the interests of the banks before those of the country. The "public private partnership" is just a convoluted way of avoiding the heavy-lifting of rolling up the banks, wiping out shareholders, separating the bad assets, and replacing management. The same is true of Bernanke's Term Asset-Backed Securities Loan Facility (TALF) which is another futile attempt to restart Wall Street's failed credit-generating mechanism, securitization. It was securitization (which is the conversion of pools of mortgages into securities) which got us into this mess to begin with. It doesn't do any good to restore in inherently crisis-prone system that only works properly when the market is going up. There are more efficient ways to recapitalize the banks than the PPP, just as there are better ways to promote consumer spending than the TALF. Treasury should be looking into debt relief, jobs programs and higher wages, instead of barreling blindly down the same dead end. There are solutions that do not involve artificially low interest rates, government subsidies for toxic waste or lavish handouts to hedge funds. They simply require a commitment to rebuild the economy on sound principles of hard work, productivity and fair distribution of the the profits.

Even industry cheerleaders, like the Wall Street Journal, are skeptical of Bernanke's TALF and have denounced it as just another boondoggle.

Wall Street Journal: "If you missed the first hedge-fund boom, now may be the time to put up your shingle. Looking at the terms of the Federal Reserve's new Term Asset-Backed Securities Loan Facility, investors using it should be able to generate hefty returns with little risk. The TALF effectively turns the Fed into a generous prime brokerage."

Who needs a free market when Obama's Politburo is more than willing to prop up private industry with hundreds of billions of tax dollars?

There is another part of Geithner's plan that is even more troubling, that is, after the banks sell their dodgy assets to the hedge funds, what will they do with the money? Consumers are retrenching, so the pool of creditworthy customers will remain small. And businesses are trying to work off existing inventory, so they won't be borrowing to increase investment or retool anytime soon. If the opportunities for lending dry up, the banks will be forced to seek unconventional means for generating profits. My guess is the banks will put a large portion of their money into hedge funds for commodities speculation, which will push the price of oil, natural gas and other raw materials into the stratosphere just like they did last year when oil shot up to $147 bbl. The banks really have no choice; 65 percent of their business was securitized investments. That door has been slammed shut for good.

"TOO BIG TO FAIL"?

The Financial Times economics editor Martin Wolf warned in Friday's column of the dangers of our present course. He said:

"If large institutions are too big and interconnected to fail... then talk of maintaining them as "commercial" operations... is a sick joke. Such banks are not commercial operations; they are expensive wards of the state and must be treated as such.

The UK government has to make a decision. If it believes that costly bail-out must be piled upon ever more costly bail-out, then the banking system can never be treated as a commercial activity again: it is a regulated utility – end of story. If the government does want it to be a commercial activity, then defaults are necessary, as some now argue. Take your pick. But do not believe you can have both. (Martin Wolf, Big risks for the insurer of last resort, Financial Times)

Citigroup is now officially a "ward of the state" although CEO Pandit and his scurvy band of pirates are still allowed to collect their paychecks and hang out by the water cooler. Citi's survival depends on the reluctant generosity of the US taxpayer who is now its biggest shareholder. The mega-bank has slumped from $58 per share to $1 per share in less than 2 years. It's now more expensive to buy a grande latte at Starbucks than it is to buy three shares of Citi...and, at least with the Starbucks, the buyer gets a buzz on. There's no upside to the Citi deal. It's a dead-loss. The real question is, how long will Geithner let this joke continue before he does his job?

Wolf is correct to draw attention to the myth of "too big to fail". In fact, the Kansas Federal Reserve President, Thomas Hoenig made the same point in a PDF released this week:

"We have been slow to face up to the fundamental problems in our financial system and reluctant to take decisive action with respect to failing institutions. ... We have been quick to provide liquidity and public capital, but we have not defined a consistent plan and not addressed the basic shortcomings and, in some cases, the insolvent position of these institutions.

We understandably would prefer not to "nationalize" these businesses, but in reacting as we are, we nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis." (Too Big has Failed, thanks to Calculated Risk)

Hoenig and Wolf are smart enough to know that the problem is not as simple as it sounds. They know that the largest financial institutions are lashed together in a net of complex counterparty contracts--mainly credit default swaps (CDS)--which run into tens of trillions of dollars, and, that if one player is allowed to default, it could pull all of the others down the elevator shaft along with it. The problem could be resolved with proper regulation which would force all CDS onto a regulated exchange so that government watchdogs could make sure that they are sufficiently capitalized to pay off whatever claims are levied against them. But, so far, no one in Congress has taken the initiative to propose the necessary regulation. Thus, the taxpayer continues to pay off hundreds of billions of dollars of insurance claims against AIG, which was so grossly under-capitalized, it couldn't meet its own obligations. The AIG fiasco provides a window into the real motivation behind financial engineering and the alphabet-soup of complex debt-instruments. (CDOs, MBSs, CDS) Wall Street knew that the fastest way to fatten the bottom line was to circumvent minimum capital requirements and expand leverage to unsustainable levels. In other words, a system of debt-fueled capitalism with only specks of capital. It worked beautifully, until it didn't.

Nobel prize-winning economist, Myron Scholes, who helped invent a model for pricing options, added his voice to the growing chorus of angry reformers who think the CDS market should be scrapped altogether. According to Bloomberg News: Scholes said "regulators need to ‘blow up or burn' over-the-counter derivative trading markets to help solve the financial crisis. The markets have stopped functioning and are failing to provide pricing signals... The "solution is really to blow up or burn the OTC market, the CDSs and swaps and structured products, and let us start over." (Bloomberg)

Treasury and the Fed have taken the position that they will not fix the system until they are forced at gunpoint. This is a prescription for disaster, not just because of growing public frustration or the free-falling stock markets, but because the banks are just the tip of the iceberg. The other non bank financial institutions are brimming with mortgage-backed sludge that will require emergency treatment, too. MarketWatch gives us a glimpse of the magnitude of the problem in last week's article "Banks fall out of bed, Citi shares under a buck":

"Market strategist Ed Yardeni's latest research shows that.....80.6%, or $7.4 trillion, of the assets held by the S&P financials companies were Level 2," he said in a research report. Level 2 assets are so-called mark-to-model, which are carried at a value based on assumptions, not true market prices."

What does "Level 2 assets" mean? It means that the financial giants are short on liquid assets--like cash or US Treasurys--and loaded with sketchy mortgage-backed paper to which they have arbitrarily assigned a value that no one in their right mind would ever pay. The entire US financial system, including the pension funds and insurance companies, is one humongous debt-bloated time bomb that is set to blow at any minute.

Surprisingly, Bernanke thinks he can simply wave his wand restart the moribund credit markets. That's what the TALF is all about. The problem is that even if the Fed buys all of the AAA securities held by the respective financial institutions, (most of them are non banks) that's still only accounts for 20 percent of the bad paper on the books. Here's what Tyler Durden said on Zero Hedge web site:

"Unfortunately for Geithner, who apparently did not read too deeply into the data, the bulk of the $1 trillion decline in securitizations came from home equity lending and non agency RMBS (Residential Mortgage Backed Securities), which reflect the "non-conforming" mortgage market, i.e. the subprime, alt-A and jumbo origination, loans which are the cause for the credit crisis, and which are rated far below the relevant AAA level. The truly unmet market, which the Treasury is addressing is at best 20% of the revised total amount." (Tyler Durden, Could TALF be the biggest disappointment yet?, Zero Hedge)

That leaves Geithner and Bernanke with few good choices. Either they expand TALF to include crappy AA (and lower) graded securities--putting the taxpayer at even greater risk--or they devise some totally new lending facility that will bypass the financial institutions altogether and issue credit directly to consumers and small businesses. There is no third option.

The problem with the TALF is that it ignores the new economic reality, that consumer demand has collapsed from the massive losses in home equity and retirement accounts. When credit markets froze last year, housing values dropped sharply raising havoc with household balance sheets and forcing a radical change in spending habits. That cutback in spending created a negative feedback loop to the financial sector which made it impossible to re-inflate the credit bubble. The ultimate size of the financial system will be determined, to large extent, by the capacity of people to borrow again which depends on many factors including job security, savings, and optimism about the future. Needless to say, the growing worry over a 1930s-type Depression will not help to lift spirits or improve the chances for a speedy recovery. That said, there are positive steps the administration can take now to restore confidence in the markets and put the ship o' state on even keel. These measures fall under three main headings; debt reduction (forgiveness), regulation and accountability. Confidence is not built on inspiring oratory or personal charisma, but concrete actions to reestablish a rules-based system that penalizes crooks and fraudsters. Recovery isn't possible without a strong commitment to these basic changes.

Mike Whitney is a frequent contributor to Global Research.  Global Research Articles by Mike Whitney

The shadow financial system is largely based in Britain
Brad Setser (CFR blog)

From: Peter Myers     

"...This suggests to me that the regulators didn't fully understand the role European banks were playing in US credit markets – or how exactly they funded their positions – until the crisis made their funding needs acute. I suspect that it took the crisis for the researchers at the BIS to be able to figure out how to use the BIS data to estimate European banks need for wholesale dollar funding...>

Posted on Sunday, March 8th, 2009 {Note that this "blog" website is run by the Council On Foreign Relations (CFR)}

http://blogs.cfr.org/setser/2009/03/08/the-shadow-financial-system-%e2%80%93-as-illustrated-in-three-

Gordon Brown wants to shine a bit more light on the shadow financial system (hat tip IPEZone). One plank of his G-20 action plan is:

"reform of international regulation to close regulatory gaps so shadow banking systems have nowhere to hide"

It isn't exactly clear though why Brown needs the cooperation of the other members of the G-20 to do increase transparency here: an awful lot of the shadow financial system is based in the UK. If the UK collected the kind of detailed data that the US collects in the TIC {Treasury International Capital System http://www.treas.gov/tic/}, a large part of the shadow financial system would either emerge from the shadows or a lot of banks – and bankers – would need to migrate. And given how much trouble has emerged from the shadows, a bit more transparency about what goes on in the UK might have helped the world's regulators (and the IMF) do a better job of providing a bit more "early warning" of budding problems.

Think of the various less-than-transparent actors that have set up shop in London

– Many sovereign wealth funds.

– A lot of the SIVs set up by US (and European) banks were legally domiciled in the UK

– Some credit hedge funds

- And most importantly, a host of European banks with large dollar books (think of them as badly regulated credit hedge funds) ran a large part of the dollar exposure through London.

There was a reason, after all, why residents in the UK were the largest purchaser of US corporate debt over the past few years. Corporate debt – in the US balance of payments data – includes asset-backed securities. Foreign purchases of such debt soared – especially from 2004 to 2007 – before falling off a cliff during the crisis.

Three recent papers – one from the Bank of Spain and two in the latest BIS quarterly – have shed a bit of light on the true nature of the all the flows through the UK over the past few years. Had there been an international "early warning" system that was on the ball – and had the UK been willing to collect the data on flows through the UK in the face of inevitable complaints that such efforts would drive business abroad – it might well have picked up on some of these flows as a sign of brewing trouble in global financial markets.

One potential warning sign: during the peak of its lending and credit boom, the US couldn't finance its external deficit by borrowing from private creditors. That is the conclusion of Enrique Alberola and Jose Maria Serena's recent Bank of Spain working paper – a paper that investigation into the role central banks and sovereign wealth funds played in financing the US current account deficit.*

Alberola and Serena used the same basic technique that I have used in the past to estimate official flows. Rather than work off the US data – which misses official flows through London – they worked off the IMF's data on global reserves and national data on the balance of payments of countries with large sovereign funds. They estimated the dollar share of the reserves of countries that don't report data on the currency composition of their reserves to the IMF (they used a conservative 60% share) and the dollar share of sovereign wealth funds (40% or so) and came to the same conclusion that I reached: at their peak, the total growth in the dollar assets of central banks and sovereign wealth funds exceeded the US current account deficit:

"the importance of sovereign external assets [sovereign wealth funds and central bank reserves] increased in the last years, surpassing the trillion dollars in 2007 and thus representing over half of gross capital inflows into the US last year."

In 2007, gross inflows were bulked up by the two-way flow associated with the shadow banking system for at least part of the year; the fact that sovereign flows exceeded the current account deficit and represented half of the gross flows is truly incredible. When revised balance of payments data data for 2008 comes out, the "sovereign" share of gross flows will be even larger.

Alberola and Serena also try to place the debate over sovereign funds in the context of the debate over imbalances – rather than say a debate over "investment protectionism." They note that the money sovereign funds recycled into external assets helped sustain the US deficit:

"reserves and SWF assets should be jointly considered for the assessment of global imbalances. Both are official capital outflows from developing to developed countries, both hinder internal adjustment in current account surplus countries, both help to cover the financing needs of deficit countries, in particular the US and therefore both contributed to sustain[ed] global imbalances."

I couldn't agree more. Obviously, though, much has changed in the last two quarters. Global reserve growth likely turned negative in the fourth quarter of 08 as private capital fled the emerging world – and the Gulf's sovereign funds are now net sellers of the financial asset of the world's mature economies. But Alberola and Serena's work still highlights that the official sector has accounted for a large fraction of the global flow of funds over the past few years, and a bit more transparency from the countries assembled around the G-20's table (China especially, but the Saudis could do more too …) would help bring some flows out of the shadows. The UK could help fill in the data on the global flow of funds by making a real effort to track the money flowing in (and out) of the UK. Efforts to bring shadowy flows to the light shouldn't hinge on the willing of China, Saudi Arabia and the Emirates to increase their transparency.

Sovereign wealth funds (and central banks that started to act like sovereign funds at the tail end of the boom) aren't the only – or even the most important – "dark" financial flow. The shadow financial system that grew up in London and elsewhere was primarily populated by leveraged private investors.Two papers (one on US money market funds' role funding European banks and one on European banks dollar funding needs) in the BIS quarterly shed some light on the role European financial institutions played in the rise – and the subsequent fall – of US credit markets.

The first paper – by Baba, McCauley and Ramaswamy – explains how US money market funds were a crucial channel for transmitting the financial stress caused by Lehman's default to Europe's banks (and then back to US credit markets).It turns out that Lehman (and no doubt other investment banks) and European banks both borrowed heavily from the US money markets. In effect, they shared a common creditor – "prime" money market funds – and when Lehman's default led the reserve primary fund to break the buck and massive withdrawals from "prime" money market funds – European banks lost access to dollar financing. Baba, McCauley and Ramaswamy write: "the run on US dollar money market funds after the Lehman failure stressed global interbank markets because the funds bulked so large as suppliers of US dollars to non-US banks."This isn't really news. There is a reason why the Fed lent $600 billion to European central banks so those central banks – the Fed was making up for collapse of dollar funding from US money market funds. (see graph 6 on p.77)

Baba, McCauley and Ramaswamy highlight the huge growth in the dollar assets of European banks over the last eight years. Those assets increased from $2 trillion to around $8 trillion (with Swiss banks accounting for about 1/2 the total). That growth "outran their retail dollar deposits," making Europe's banks reliant on wholesale dollar funding in much the same way that the growth in the assets of the US broker dealers made them reliant on wholesale funding. US money market funds that weren't limited to Treasury and Agency paper happily met this need: "competition to offer investors higher yields, however, led them to buy the paper of non-US headquartered firms to harvest the Yankee premium."

The BIS estimates that US money market funds were supplying $1 trillion of credit to non-US banks in mid-2008 (dollar denominated European money market funds supplied another $180b ….). That is far more dollar financing than supplied by the offshore dollar deposits of the world's central banks: "by contrast, central banks … provided only $500 billion to European banks at the peak of their holdings in the third quarter of 2007."Still, those looking for a direct (rather than indirect) link between central bank reserve growth and boom in lending to US households can find a link here. A fraction of central bank dollar reserves were held in deposit in European banks – and another fraction was invested in onshore and offshore dollar-denominated money market funds. European banks used those sources of dollar "funding' to buy securities backed by loans to US households. The growth in their balance sheets undoubtedly explains the huge increase in cross border flows (outflows from US money market funds financed the inflows associated with European banks purchases of US securities) during the boom years – and large corporate debt purchases through the UK.

The second BIS paper — by Patrick McGuire and Goetz von Peter on the "US dollar shortage in global banking" — uses the BIS banking data (actually, I would say that they tortured the banking data, as the data didn't yield its secrets without a tremendous amount of effort) to estimate European banks need for dollar funding. It is superb.The results are interesting, to say the least. They confirm that the losses that money market funds that held Lehman paper were a key channel of contagion, as European banks depended on US money market funds to meet their need for dollar funding.Among other things, McGuire and von Peter find:

– "European banks experienced the most pronounced growth in foreign claims relative to underlying measures of economic activity."– "After 2000, some banking systems took on increasingly large net on-balance sheet positions in foreign currencies, particularly in US dollars. While the associated currency exposures were presumably hedged off balance sheet, the buildup of large net US dollar positions exposed these banks to funding risk , or the risk that their funding positions could not be rolled over."– "A lower bound estimate of banks' funding gap … shows that the major European banks funding needs were substantial ($1.1 to $1.3 trillion by mid-2007)."

– UK banks, for example, borrowed in pounds sterling [some $800b] in order to finance their corresponding long positions in US dollar, euros and other foreign currencies. By mid-2007 their long US dollar positions surpassed $300b, on an estimated $2 trillion in gross US dollar claims. Similarly, Germany and Swiss banks net dollar books approached $300b by mid-2007, while that of Dutch banks surpassed $150b …. " Setser note: this created large positions that needed to be hedged, and meant that if UK banks couldn't raise a lot of sterling funding to swap into dollars, they would need to go out into the market and borrow dollars directly …– The term structure of the fx swaps Eurpoean banks used to transform their pound and euro funding into dollars "are even short-eterm on average" than dollars borrowed on the interbank market.

– "these estimates suggest that European banks' US dollar investments in non-banks [read holdings of dollar securities and corporate loans] were subject to considerable funding risk …. The major European banks US dollar funding gap reached $1.1-1.3 trillion by mid-2007. Until the onset of the crisis European banks had met this need by tapping the interbank market ($400 billion) and borrowing from central banks ($380 billion) and used FX swaps ($800 billion) to convert (primarily) domestic currency funding into dollars."

By the way, US banks were net borrowers from the rest of the world – but most of their borrowing came from a few Caribbean islands – and those islands borrowed heavily from "non-bank" counterparties in the US. The BIS doesn't think this represents a true external flow: "this could be regarded as an extension of US banks domestic activity since it does not reflect (direct) funding from non-banks outside the United States." The subprime crisis in August 2007 put these funding arrangements under stress. And they effectively collapsed after Lehman, leading to a scramble for dollars – or a "dollar shortage." In the fourth quarter, the US government was a net LENDER to the rest of the world. Inflows from central banks were dwarfed by the $400 billion in swap lines the US provided European central banks. That is rather strange; deficit countries usually aren't net lenders … but, well, a lot of institutions really were desperate for dollars.

The main source of stress on European banks came from the withdrawal of money market funding and the difficulties obtaining currency swaps. But it seems like European banks also lost another source of dollar funding: the world's central banks.Emerging economies were facing their own liquidity shortage – and emerging market banks in particular. Their home central bank helped them out. Countries with lots of dollar reserves though didn't need to turn to the Fed for dollars. They could withdraw dollars from European banks and put them on deposit in their local banking system.

"A portion of the US dollar foreign exchange reserves that central banks had placed with commercial banks was withdrawn during the course of the crisis. In particular, some money authorities in emerging markets reportedly withdrew placements in support of their own banking systems in need of US dollars. Market conditions made it difficult for banks to respond to these funding pressures by reducing their dollar assets …. "

That links the work of the BIS back to the work of the Alberola and Serena of the Bank of Spain. It was long argued that official investors were intrinsically stabilizing investors – and thus that they would never trigger a funding crisis or add to market distress. And it is certainly true that central banks haven't triggered a dollar crisis. Indeed, they almost certainly prevented one in 2006 and 2007 when they added crazy sums to their reserves, preventing the dollar from falling against a host of emerging currencies. At the same time, central bank reserve managers haven't been a stabilizing force in the credit market during this crisis.

– Central bank reserve managers – led by China and Russia - shifted massively out of Agencies and into Treasuries. And that shift came after a long period when central banks kept buying Agency bonds even as (in retrospect) the quality of the Agencies balance sheet was eroding, as they were lending against collateral inflated by housing bubble.

– Central banks shifted dollars out of European banks short of dollars to their home countries banking system.

The first flow represents a flight to safety. The second flow represents a flight from the risk associated with global banks – but putting funds on deposit in shaky local banks isn't necessarily the safest of investment either. It was a flow driven by the banks need to stabilize their own markets. In both cases the offsetting flow – the flow that prevented an even deeper crisis than we have seen to date – came from the US Federal Reserve. They should get a bit of credit.

I don't blame the central bank reserve managers for adding to the distress in dollar-denominated credit markets. Central bank reserve managers' core mission is to safeguard their countries external assets and meet their own countries need for hard currency financing, not to stabilize the international financial system. But I do think that there should have been a bit more discussion of the various ways the actions of central banks could add to a crisis. And perhaps the central banks – and the IMF — shouldn't have been quite so willing to argue that official investors were an intrinsically stabilizing presence in the market.

*It is striking that this paper came from the Bank of Spain, not the IMF. While the Bank of Spain was delving into the role the official sector played in financing the US deficit, the IMF's 2007 article IV report by contrast emphasized private flows, arguing that the United States comparative advantage at producing complex financial products would sustain external demand for US assets. Bad call. There is no hint in the IMF's analysis that most such demand was coming from the SIVs US banks had set up in London/ European banks that relied on US money market funds to support their dollar balance sheets.

**It is notable, at least to me, that the regulators focused on the risk Lehman's failure posed to the CDS market but not – at least from what has been reported – on the risk that Lehman's failure posed to the money markets, and thus to all the institutions that relied on the money markets for financing. This suggests to me that the regulators didn't fully understand the role European banks were playing in US credit markets – or how exactly they funded their positions – until the crisis made their funding needs acute. I suspect that it took the crisis for the researchers at the BIS to be able to figure out how to use the BIS data to estimate European banks need for wholesale dollar funding.

Monday, March 16, 2009

Madoff 'Ponzi scheme' scam: Jews avoiding American taxes?
from Xymphora - Blog

Is the Madoff 'Ponzi scheme' itself just another misdirection to cover up a massive plan by rich American Jews to avoid paying American taxes? The Jews don't mind having American taxpayers pay for the Wars For The Jews, but perhaps they'd prefer to pay their taxes to another country, say, Israel. Consider:

1. It was scammer Madoff himself who immediately fessed up and labeled his operation a 'Ponzi scheme'. 'Ponzi scheme' has become the way Madoff's operation is always described by the Jew-controlled media. People understand that a Ponzi scheme is a method whereby victim investors are cheated by an unscrupulous financier.
   
2. At the time of his guilty plea, Madoff was at great pains to distinguish his rogue 'hedge fund' operation from the 'legitimate' operations of the rest of his family. In fact, the quick plea seems to have been his way of inoculating the rest of the business against prosecution or investigation.
3. At the time of the plea, the government stated that it was aware of $250 million in transferred funds from the American operation to a London office, with the money being returned to give the impression that Bernie was actually investing in Europe. This explanation, which presumably came from Bernie, makes no sense. Bernie's investors would have no way of knowing about the transfer, so how would it help to sell the legitimacy of his business?
4. Massive amounts of money have gone missing. The estimated losses started at $50 billion, are now over sixty, and some are saying may be $100 billion. Bernie has less than $1 billion in assets. Even if we are conservative, and consider the estimates to be overblown and based on the rates of return Bernie claims he was making, there are still tens of billions of dollars which have simply vanished into thin air. Don't believe Jewish attempts to try to minimize the scam: at least $170 billion in real money moved through the Madoff operation.
   
5. The original suspicions of Harry Markopolos were based on the fact that Bernie's hedge fund didn't resemble any other hedge fund in the world. Most odd is the fact that Bernie didn't charge anywhere near market rates for his services.
   
6. You had to be invited, and for the most part be Jewish, to 'invest' with Bernie. Odd.
7. Wayne Madsen has listed many of the suspicious business and neighbor connections of Madoff, with some very interesting characters including many who are described as belonging to the 'Russian' mob. Of course, 'Russian mob' is the code word used by the Jew-controlled media to describe the international Jewish mafia, a group which seems to be heavily involved in building Anti-Assimilation-Land.
   
8. It is odd that all the Jewish charities that were supposedly 'wiped out' by Bernie don't seem to have curtailed their operations.
   

Consider the alternative explanation, which seems to fit the facts: Bernie takes the 'invested' money, moves it to London and on to Israeli banks. The 'investors' can then pick up the money there, and have the option of paying no tax or paying Israeli taxes on it. Why all the convoluted operations just to move money off-shore? The 'losses' suffered by the poor victim Jews will now be tax-deductible in the United States, meaning that they will neatly turn their American tax obligations into Israeli tax obligations, with the possible option of avoiding paying taxes at all. No American tax authority will dare challenge the tax deduction claims of these poor Jewish victims (it is the 'new Holocaust'; of course, some of the smaller 'middle class' investors we keep hearing about in the Jew-controlled media may really have been scammed). There will also be a bonus from a compensation fund for investment losses (and don't be shocked if the Jew-controlled Congress doesn't create a special Madoff compensation fund). The Madoff 'Ponzi scheme' may be no Ponzi scheme at all, but a massive tax avoidance operation, again intended to help finance Anti-Assimilation-Land.