The Fed: Our Next Troubled Bank?

by Mike Larson   04-24-09

The Federal Reserve is watching the backs of U.S. banks. But sometimes I wonder, “Who’s watching the Fed’s back? Is the Fed our next troubled bank?”

You see, all of this garbage paper that’s going bad — the troubled residential mortgage backed securities (RMBS), the commercial mortgage backed securities (CMBS), the asset backed securities (ABS), the Fannie Mae bonds, the corporate loans, and so on — hasn’t just gone “Poof.”

Instead, more and more of it has been landing on the Fed’s doorstep — either through direct ownership or as collateral against Fed loans that keep getting rolled over.

The result? The Fed’s once pristine balance sheet is starting to look more and more like the balance sheet of a troubled financial institution.

From AAA to
Something Else Entirely

What do I mean? Well, take a look at this April 26, 2007, Federal Reserve Statistical Release. Table 2, the Consolidated Statement of Condition of All Federal Reserve Banks, shows the breakdown of the Fed’s assets back then.

In 2007, 89 percent of the Fed’s assets were in risk-free Treasuries. Since then, that number has plummeted to a scary 24 percent.

You’ll see that the Fed banks listed total assets of $883.5 billion at the time. The lion’s share of those assets — $787.1 billion, or 89 percent — were “AAA” quality U.S. Treasury bills, notes, and bonds. There were a few other assorted line items (gold, bank premises, etc.) … but that’s about it.

Now compare that two-year old balance sheet, to this multi-headed hydra of a balance sheet that came out a few days ago. The equivalent table (number 9) shows that total Fed assets have exploded to $2.19 TRILLION. And those plain-vanilla, risk-free Treasuries? They make up just $526.1 billion, or 24 percent, of Fed assets!

The Fed now also owns more than $355 billion of mortgage backed securities and $61 billion in debt issued by Fannie Mae, Freddie Mac, and Ginnie Mae. Term auction credit comes to $455.8 billion. Those are short-term loans against just about anything and everything — from auto loans and credit card receivables to Brady Bonds and CMBS.

The Fed is also holding $238 billion in commercial paper as part of an October 2008 program to help corporations fund short-term debt obligations. And it has $111 billion in so-called “other loans.” This all-purpose category includes loans made to primary dealers ($12.9 billion), bailout baby AIG ($45.1 billion), and loans made as part of the Fed’s Term Asset-Backed Securities Loan Facility ($5.1 billion).

Finally, the Fed has lent money to so-called “Maiden Lane” LLCs that acquired dodgy asset portfolios as part of the Bear Stearns and AIG bailouts. The grand total there comes to $72 billion.

Bottom line:

• The quality of the balance sheet of the U.S. central bank is deteriorating. 

• The Fed is now heavily burdened by the same kind of crappy paper that has been hammering private U.S. banks for several quarters. 

• And the Fed banks are holding total capital of just $45.7 billion against the sum total of $2.19 trillion in assets, meaning the Fed is leveraging its capital 48-to-1. That compares to only 27-to-1 two years ago.

What’s the Risk?

With the Fed doing its best to tarnish its balance sheet and the Treasury borrowing like crazy (not to mention the Fed monetizing some of that debt), the natural question becomes: “What’s the risk?”

The answer is that it all comes down to the reaction of the capital markets …

• Do investors continue to aggressively bid on U.S. Treasuries at our debt auctions? 

• Do foreign creditors, who hold more than 53 percent of the privately held Treasury debt outstanding, start balking at supporting our profligacy? 

• Does the U.S.’s AAA credit rating come under closer scrutiny? 

• And does the dollar start to reflect the fact that the Fed is throwing money around like a drunken sailor — and taking on any and all kinds of crummy assets?

These questions likely won’t be answered today, tomorrow, or next week. We may not learn for months or even quarters. But that doesn’t mean we shouldn’t discuss these risks now … that those risks aren’t very real … and that you don’t want to start taking some protective steps now.

Now might be the time to get rid of long-term U.S. bonds and buy some gold.

I warned about an impending blow up in residential real estate in 2005. If you sold housing, construction, and mortgage stocks back then, you dodged the worst meltdown in modern history. I warned that commercial real estate was in big trouble in early 2007. If you sold your REITs then, you dodged the biggest crack up in office, industrial, and retail real estate shares in ages.

Now, I recommend you consider buying some gold and dump the heck out of any long-term U.S. bonds. Because some day, the trashing of the Fed’s balance sheet is going to matter, and in a potentially huge way.

Until next time,

Mike

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Obama meets with bank, credit card executives

By Barry Grey
24 April 2009

President Barack Obama met Thursday at the White House with executives of major banks and credit card companies amidst growing public anger over sudden increases in interest rates and fees, in many cases by companies that have received billions of dollars in taxpayer bailout money.

Obama, who pledged during his presidential campaign to curb abuses by credit card firms, was silent on the issue until last week, when media reports emerged detailing how firms were doubling and tripling their charges to customers, including those with good credit who had remained current on their payments.

These reports coincide with others showing that banks that have received cash, cheap loans and debt guarantees from the $700 billion Troubled Asset Relief Program (TARP) and other government programs are ramping up home foreclosures while continuing to reduce lending. First the Bush and now the Obama administration have defended the transfer of public funds to Wall Street as the only means of ending the credit crunch and resulting recession.

Trillions have been pumped into the banks, but the recession has deepened, unemployment has soared and millions of people have been thrown into poverty and homelessness. The banks have used the bailout money to bolster their balance sheets and generate profits by speculating on turbulent financial markets and by finding ways to cash in on the collapse in home prices. They have intensified their assault on the working class, slashing hundreds of thousands of jobs, driving people out of their homes and raising the cost of credit upon which most Americans depend to pay their bills.

They adamantly oppose even the most modest restrictions on their activities, including certain limits on executive compensation, enhanced power of bankruptcy courts to alter mortgage terms for distressed homeowners, and laws that would restrict their ability to arbitrarily increase charges on credit card holders.

Obama’s White House meeting was typical of his public relations efforts to placate public opposition while taking no serious measures to rein in the banks. Participants, besides Obama and his top economic aides, included executives from Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, US Bancorp, Visa, Mastercard, Capitol One Financial, American Express, Discover Financial Services and several other firms. Also present was the president of the American Bankers Association, which is lobbying against congressional bills that would curb abuses by credit card issuers.

Following the closed-door meeting, Obama told reporters, “We’re confident we can arrive at something that is commonsensical.” Seeking to reassure the bankers, he added, “We want to preserve the credit card market but we also want to do so in a way that eliminates some of the abuses and some of the problems that a lot of people are familiar with.” He did not say which abuses would be allowed to continue.

One indication of the seriousness of the administration’s effort was provided by Lawrence Summers, the director of the White House’s National Economic Council. According to reporters, he dozed off during Obama’s brief remarks to the press.

Executives leaving the meeting said it was “constructive.” They are confident that they will succeed in blocking passage of a bill, dubbed the “Credit Cardholders’ Bill of Rights,” that is moving through Congress. On Wednesday the bill was approved by the House Financial Services Committee, but a Senate version is opposed by Republicans on a party-line basis and by some Democrats, all but insuring its defeat.

The banks and credit card companies maintain that legislation is not necessary since the Federal Reserve has already announced restrictions on interest charges and fees. However, those regulations are not slated to take effect until July of 2010, giving the banks ample time to ramp up charges in advance of the new rules.

Earlier on Thursday, the special inspector general appointed to monitor the TARP program testified before the Joint Economic Committee of Congress and indicated that the bailout program is rife with conflicts of interest and fraud.

Neil Barofsky, a former prosecutor, told the panel that he had already initiated 20 criminal investigations into securities fraud, insider trading, collusion, price-fixing, money laundering and other illegal activities in relation to the government bailout. He suggested that there would be many more probes.

On Monday, Barofsky released a 250-page report to Congress on the TARP program in which he decried the refusal of the Treasury Department, despite his repeated urgings, to require firms that receive taxpayer handouts to report on how they are using the government money. He noted that the Obama administration has signed off on another $30 billion for the insurance giant American International Group (AIG), which had already received some $150 billion, without any requirement that the company explain what it has done with its bailout money.

The TARP program, he wrote, which began as a $700 billion plan to purchase toxic assets from the banks, has morphed into twelve separate programs involving more than $3 trillion in government cash, loans and loan guarantees—an amount roughly equal to the annual federal budget.

In his report and in his congressional testimony, Barofsky focused on the new bailout program detailed on March 24 by Treasury Secretary Timothy Geithner. He warned that the “Public-Private Investment Program” (PPIP), under which Wall Street investment firms will be given low-cost government loans and guarantees against losses to purchase toxic assets from the banks at inflated prices, was “inherently vulnerable to fraud, waste and abuse.”

He said that the program, which is to be run by the private firms, with between two-thirds and 92.5 percent of the funding provided by the government, had “significant issues relating to conflicts of interest facing fund managers, collusion between participants, and vulnerabilities to money laundering.” He urged that the program not go forward without the addition of serious safeguards against fraud.

In his testimony before the Joint Economic Committee, Barofsky said that the program was designed so as to allow the private fund managers to set the price for the securities purchased from the banks. “This is a lot of economic power given to a small number of fund managers,” he said. He pointed out that fund managers would likely be buying the same mortgage-backed securities they had in other accounts, giving them an incentive to pay inflated prices and thereby increase the value of their previous investments, which they could subsequently unload at a huge profit.

“The banks will also make a huge profit,” he said. “And when the securities go back to their real market price, the taxpayer will pay the loss.”

He also warned that the incorporation of the Federal Reserve’s Term Asset-Backed Securities Loan Facility (TALF) into the Public-Private Investment Program added another level of potential fraud. Investment firms running Public-Private funds would be able to borrow additional money under the TALF program.

That program, using $80 billion in TARP funds to leverage $1 trillion in Fed loans, was initially designed to subsidize the issuing of new securities backed by consumer loans. Now it is to be used to subsidize the purchase of existing toxic asset-backed securities on the banks’ books.

He decried the fact that the Federal Reserve was relying on credit rating agencies to rate the toxic assets to be purchased under TALF and the PPIP, noting that the same agencies had contributed to the financial collapse by giving dubious mortgage-backed securities their highest rating.

In effect, he suggested, the program would enable the banks to offload the worst of their bad debts, generating massive profits for Wall Street and huge taxpayer losses.

Asked at the hearing whether there were any provisions in the TARP bill passed last October that required banks to report on their use of bailout money, he said, “No.” Without fundamental changes in the structure and management of the bailout programs, he said, there would be “potentially catastrophic taxpayer losses.”

Barofsky was asked about a report published that morning by the Wall Street Journal citing testimony by Bank of America CEO Kenneth Lewis that Federal Reserve Chairman Ben Bernanke and then-Treasury Secretary Henry Paulson pressured him to conceal the dire financial position of Merrill Lynch last September, when the Bush administration engineered the takeover of the investment bank by Bank of America. Merrill Lynch lost more than $15 billion in the fourth quarter of 2008, liabilities that led to a government bailout of Bank of America last December.

Barofsky said that his office was investigating the Bank of America takeover of Merrill. He listed six audits he was conducting, including, besides the Bank of America deal, the use of bailout funds, compliance with executive compensation limits, external influences, AIG executive bonuses, and AIG counterparty payments.

The latter concerns the fact that AIG has used its government bailout funds to pay off banks and other firms that had entered into credit default swaps with the insurance giant at 100 percent of the face value of the deals, rather than forcing its counterparties to accept reduced payments.

One such deal that is ripe for criminal investigation involves Goldman Sachs, former Treasury Secretary Paulson and the current CEO of AIG, Edward Liddy. It has emerged that Paulson, who was CEO of Goldman before becoming treasury secretary under Bush, designed the AIG rescue so as to allow AIG to funnel $13 billion in bailout money to his former bank. He picked Liddy, a former board member of Goldman, to become the new CEO of AIG. Liddy, meanwhile, retains an investment of more than $3 million in Goldman Sachs.

Obama’s treasury secretary, Geithner, was president of the Federal Reserve Bank of New York at the time and played a critical role in designing and implementing the TARP program and the bailout of AIG. That neither he, nor Obama, nor the Democratic-controlled Congress has any intention of implementing the changes proposed by Barofsky was underscored by Geithner’s testimony Tuesday before the Congressional Oversight Committee for TARP.

Although Geithner’s appearance occurred the day after Barofsky released his report to Congress and the day it was released to the public, none of the committee members raised it. Geithner, for his part, announced that the “vast majority” of banks were more than adequately capitalized, stressed that banks shown to need more capital by government “stress tests” would have many options for raising money, in addition to government purchases of their stock, and warned Congress against placing new requirements on bailed out firms.

His testimony was taken as a pledge that the Obama administration would continue to run interference for Wall Street and shield the wealth of the financial elite. It sparked a 127.8 point rise in the Dow, with bank stocks recording double-digit gains for the day.

www.wsws.org

China challenges US dominance in Latin America

By Luis Arce
24 April 2009

China’s recent announcement of multi-billion dollar deals with several Latin America countries will strengthen its already substantial presence in a region the US has historically regarded as its own backyard.

The Asian giant is negotiating with Venezuela to double a development fund to $12 billion.

In addition, China announced it was prepared to lend $1 billion to Ecuador to build a hydroelectric plant, and $10 billion to Brazil’s national oil company.

Even Jamaica, heavily indebted and confronting growing unemployment, turned to China after failing to secure credit from the US or Britain. The Caribbean island nation negotiated $138 million in loan packages from Beijing, turning China overnight into its principal financial partner.

But it is the $10 billion swaps in Chinese currency, the yuan, with Argentina that most clearly expresses the change in relations emerging from the present world financial crisis.

“This is how the balance of powers shifts quietly during times of crisis,” David Rothkopf, a former official in the Clinton administration, told the New York Times. “The loans are an example of the checkbook power in the world moving to new places, with the Chinese becoming more active.”

The Argentine deal brings to $95 billion the amount in currency-swaps negotiated by China. Similar deals were negotiated with Indonesia, Malaysia, South Korea, Hong Kong and Belarus. China is the largest holder of US Treasuries with $740 billion, and is looking for ways to do business away from the US currency.

China fears that the US financial crisis will undermine the dollar’s position as the world reserve currency. Last March, China called on the International Monetary Fund to create a “super-sovereign reserve currency.”

The yuan swap with Argentina was a direct blow to the US, which recently approved $30 billion swaps each for Brazil and Mexico, but was unwilling to extend a line to Argentina, which has yet to clear up its defaulted debt to the Paris Club.

The $10 billion currency swap provided a much-needed sign of confidence in the Argentine economy, giving it a means of counteracting its precarious position in the world financial markets.

“News of the China credit last week makes it look as though default isn’t a viable option now for the government, so these bond prices are inviting many investors to take positions,” Paulino Seoane, a portfolio manager with Buenos Aires-based Lopez Leon Brokers, told the New York Times.

The financial markets and the local press welcomed the currency-swap announcement.

The Argentine peso rose 0.5 percent, its largest gain this year in a four-day rally, and the yield in Argentina’s dollar bonds maturing in 2033 dropped 1.4 percent.

Alberto Ramos, a Latin American economist at Goldman Sachs in New York, told Bloomberg News that the agreement with Argentina is a “symbolic move and an indirect way to shun the US dollar.” The deal will promote bilateral trade and direct investment by allowing one country to pay for imports in the other nation’s currency.

The currency swap will serve as a precedent to use China’s yuan as an alternative reserve currency. “The yuan is one of the currencies with the greatest potential and has a significant role to play in the current redesign of the international monetary system,” Argentina’s central bank said.

These statements underscore the US loss of influence in the region, exacerbated by the years of Washington’s neglect of the region under the Bush administration. President Barack Obama sought to recast US relations with Latin America during his recent trip to the America’s Summit, but a change in rhetoric cannot reverse these more fundamental economic processes.

The strength of the US dollar is diminishing, while China’s currency is emerging as a viable alternative for emerging countries, which are struggling to overcome the collapse in commodity prices as result of the world recession.

China’s influence in Latin America has been increasing steadily over the past decade. Today, it is the region’s second largest, after the US. Chinese-Latin American trade has been growing at an impressive pace. It reached $35 billion in 2004, a 50 percent increase over the previous year.

China’s immediate interest in Latin America is to ensure access to the raw materials the region produces. Commodities imported by China include fishmeal, soybeans, oil and gas, iron ore, copper, steel, timber and coffee from Chile, Peru, Brazil, Argentina, Ecuador, Venezuela, Bolivia and Colombia.

But, with the US in its deepest financial crisis in seven decades, China’s move into the region goes well beyond satisfying its immediate needs for raw materials to fuel its industrial growth.

In the past, China had engaged in a series of steps to increase its presence in Latin America. In a 12-day tour to Latin America in 2004, President Hu Jintao said China would invest $100 billion in the next 10 years.

In Argentina, Mr. Hu unveiled nearly $20 billion in new Chinese investments, much of it in railways and energy exploration. Commercial activity flourished between the two countries. Total trade between Argentina and China, including Hong Kong and Macau, totaled $965 million last February, according to Argentina’s national statistics institute.

China is Brazil’s second-largest trading partner and at one point China displaced the US as the leading purchaser of Chilean copper. In Brazil, Peru, Ecuador and Colombia, China has been actively pursuing joint ventures in strategic industrial areas like refining, pipelines and exploration of energy resources.

The largest Chinese commitments in Latin America have been with Venezuela. In 2007, the two countries signed 11 bilateral agreements to deepen cooperation in areas of energy, technology and financing. Central to the agreements was a plan to increase the supply of Venezuelan oil to China.

China has accounted for 40 percent of global growth in oil demand over the past decade. Its consumption in 20 years is projected to rise to 12.8 million barrels a days. (Today, the US consumes 20.4 million barrels a day.) Most of China’s oil will have to be imported.

While Venezuela now exports 60 percent of its oil to the US, the agreements between Beijing and Caracas could change that. Venezuela aims to triple its exports to China to one million barrels a day by 2013. (Today, the US consumes 1.5 million barrels a day of Venezuelan oil.)

One of the agreements reached between China and Venezuela in 2007 calls for $6 billion to be invested in various development projects in both countries and to promote a cooperative relationship between them, according to venezuelanalysis.com.

The Chinese Development Bank will contribute $4 billion, and Venezuela’s National Development Fund (Fonden) will provide the other $2 billion. Venezuelan President Hugo Chavez has stated that the fund could grow to $10 billion in the near future.

In addition, venezuelanalysis.com reported, Venezuela’s Social Development Bank (Bandes) and the Chinese Development Bank are creating a joint technical office to direct future strategic development projects in infrastructure, industry, and energy.

The two countries also plan to increase China’s oil refining capacity and to develop the necessary fleet of oil tankers to transport the oil to the Chinese market.

Also contemplated is the formation of joint companies to produce telecommunications equipment in Venezuela such as cellular phones to be sold throughout Latin America, and electrical appliances such as refrigerators, stoves and air conditioners.

The many years of joint collaboration between the two countries led to Chavez’s sixth visit to China on April 8 and 9. The Venezuelan president used the occasion to launch another left-nationalist denunciation of Washington and to declare that “the center of gravity of the world has moved to Beijing,” laying the basis for a “new world order.” The interest of the ruling Chinese Communist Party, however, lies primarily in securing access to Latin American natural resources.

Reporting on Chavez trip to the Middle East and China, the Brunei Times web site said, “While China’s Communist leaders have been low key in their response to Chavez’s political rhetoric, Beijing’s state-run industries have been eager to use Venezuela as a jumping-off point for their entry into South America.”

In an announcement that surely will provoke consternation in Washington, the Venezuelan daily El Universal reported on a joint political agreement reached in Beijing: “The Venezuelan ruler announced that members of his United Socialist Party of Venezuela (PSUV) are to be trained at the Central Party School, as proposed by Xi.”

Xi Jinping is the Chinese Vice President who is likely to succeed Hu Jintao as leader of the Communist Party of China in the party congress of 2012. The announcement points to China’s growing economic power in Latin America being used to increase its political and even military influence in the region, defying the US in both spheres.

Such moves indicate that China’s interests in the region are long term. In recent years, China and Venezuela have been discussing the possibility of building a Panamanian pipeline or, alternatively, one crossing Colombia.

The pipelines would allow the shipping of crude oil from a port in the Pacific Ocean in supertankers too big to pass through the Panama Canal. Such a project will not eliminate the economic importance of the Panama Canal—a key symbol of US dominance of the region throughout the 20th Century—but will diminish its significance.

Chinese investments and mutual visits of Chinese and Latin American heads of states will unquestionably increase China’s say in the economic and political future of Latin America, directly challenging US supremacy. Early this year, China became a member and contributor to the Inter-American Development Bank, where the US has exercised quasi-dictatorial powers since its creation after World War II.

As the New York Times reports, “Just one of China’s planned loans, the $10 billion for Brazil’s national oil company, is almost as much as the $11.2 billion in all approved financing by the Inter-American Bank in 2008.”

www.wsws.org