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Downturn, Inflation and Tax Policy
So Hank Greenberg says on CNBC that AIG is a "national treasure" and wants the Fed to loan it $70-80-90 billion. Last time I looked no nation’s treasury owned AIG, but Hank Greenberg, who was kicked out of that company three years ago over dubious accounting practices, owns 11 percent of all AIG shares.
But anyway – should the Fed or Treasury loan money to AIG?
No. There is no way AIG can survive and while such a loan would cover part of its losses it would never be repaid.
Should the Fed lower interest rates?
No. Fed interest rates at this point do not matter at all.
The overnight interest rate for interbank loans was 6% yesterday, 4% over the Fed rate while it is normally only a quarter or a half percent over the Fed rate. What is missing now is trust in the solvency of any partner in the financial markets. The need to borrow $90 billion is not simply a ‘liquidity problem’. Nobody wants to lend if their is quite a chance that the money will not come back and that there are now no longer ways to hedge such deals.
This insecure situation will continue. The Dow and S&P may rally a bit from here, AIG failure or not, and will tank again after a few days or weeks. The loan crisis – mortgages, HELOCs, car loans, credit card loans etc – which is the point of origin of the general economic crisis has not even reached its peak. That will come at the end of this year or next spring.
Only then will the system really falter and only then the rubber will really hit the road, i.e. Main Street. The really bad news will come from the big industrial companies in the 2nd quarter reports in 2009. Soon after that the Dow will see the low of the cycle and it will stay there for years to come.
Between now and then we will see lots of smaller banks fail and we will see some big ones going under. Hedge funds and private equity groups will silently close down as they will not be able to get more capital or credit. Leveraged Buy Out deals will be history. The FDIC will go bust and the taxpayer will have to carry that additional burdens. Private pension plans will be in very deep doodoo.
Next year there will be lot of talk about deflation and the Fed will use that talk as justification to inflate massively.
Does anybody remember any serious Fed talk and measures against inflation in the last 15 years? I do not. So while this whole bubble, first tech, than credit, build itself via a lax monetary policy, there never was official inflation that would have required some restrictive Fed measure. But as the bubble now finally breaks there will be serious talk about deflation and it will be used to seriously inflate and to devalue the dollar.
It is a totally dishonest scheme, but it will be the only way the U.S. will be able to repair its economy and balance sheet.
Inflation and currency devaluation is a very regressive kind of unofficial tax. It hits the poor and the middle class much stronger than the richer folks.
One can adjust fiscal policies to somewhat alleviate that effect. Increase the tax rate for income over $1 million to some 80%, over $500,000 to some 60% etc and lower regressive taxes like the sales tax.
With such a progressive tax policy the burden of inflation, which is needed to repair the national U.S. balance sheet, can be put equally on everyone.
From fool’s highly informative link in the Wild Ride thread :
In addition, The Fed has announced that it will take equities as collateral for loans. “Equities” is a fancy name for stocks.
That’s right – for the first time in history, now banks can take stocks to the discount window. Maybe even their own stocks.
The Fed has gone from taking only the highest-quality securities – “AAA” rated debt instruments – to taking everything up to and including the most dangerous (common stock) all at once!
Now I may be blind but I’ve read The Federal Reserve Act multiple times and nowhere do I see where equities can be taken to the window (or anywhere else for that matter) for Fed Credit.
If they intend to actually do this, its quite clear they don’t care what the law says. They’re going to do it anyway, and their precedent is that you sat back and allowed them to take equity when they bailed out Bear Stearns, and said nothing! They will do anything they want by citing “exigent circumstances” and claim blanket authority.
What’s worse, this effectively makes The Fed a margin lender on the equity markets! You think they don’t have a reason to interfere in the market eh? Oh boy, now they have billions of reasons, all of them sitting on their balance sheet! Fair and open markets? Bah!
Note carefully folks – this effectively makes The Fed LONG (that is, a “buyer”) of STOCKS.
What’s even better is that they don’t eat their own losses if there are any – they’re yours!
That’s because The Federal Reserve Act says that the profits (or losses) from The Fed flow through to the Treasury (after operating expenses) which means that now, suddenly The Federal Government is potentially directly exposed to losses in the stock market!
Now it has always been true that The Government “loses” when the market goes to hell as it gets less in the way of tax receipts. But that’s different than suffering an actual capital loss – and that is now possible.
The implications of this tectonic shift within the banking framework are as yet to be seen, but this lowering of securities standards by the Feds is essentially the transfer of risk for shonky investments in equities from the commercial money houses to the US taxpayer, and with the risk the obligations to cover the losses. In times when the S&P could easily fall another 20% by years end, this will have grave consequences, possibly triggering a ruinous domino effect throughout the US and entangled nations.
Although AIG has an alleged $1 trillion in assets, it can’t raise $50 billion. Who would have this sort of money at this point in time anyway? Certainly not people who can afford to loose it. So they wonder how much the assets are really worth. How much risk have they insured for loans which will or have already gone bad? When you hear announcements of “imminent death if $75 billion aren’t raised within 48 hours”, then one doesn’t have to be a rocket scientist to predict the future of this company in a downward spiralling economy. Too big to fail they say. Hah, too big to succeed I say, the giant has already stumbled and lost its balance, and no arm will be extended for fear of being dragged down with the helpless giant. So instead the Fed roles out the safety blanket to catch the falling juggernaut, taking on a 80% stake in the insurance colossus, in effect becoming the insurer of many commercial risks across the world. The costs of this venture could potentially be catastrophic for the US treasury.
The US government coffers, already running on empty, haemorrhaging from ridiculously expensive wars on foreign shores and tax cuts to the high income earners, will have to cop further billions of dollars in losses. The thrashing of equity values, the current implosion of global stock markets will continue for quite some time, but from now on the losses will be crystallising in the US treasury’s P&L. Where exactly is the treasury going to get the money from that will be needed to cover the deficits?
Tax increases? Sell the Empire State to China? Reduce the public service budget by 5% and start laying of employees? With an at best stagnating economy, falling corporate earnings, the tax revenue will decrease. A rise in unemployment figures means more social security outlays. The foreign capital drip which keeps the patient alive for the moment, apart from positioning the US in a dependency that could easily translate into being controlled by foreign powers, is under current global conditions slowly drying up and shouldn’t be taken for granted.
Who ever wins the next election will have to make some tough decisions, but won’t. The mugs in congress, no matter which tentacle they belong to, motivated by self-interest, have been sitting on their hands forever. Stooges, most if not all of them, people who taught us for decades that we best expect nothing so we won’t be disappointed. And that all talk-no action squad, strikingly ignorant and lame for as long as they’ve been in office, are representing us in the battle with the conglomerates. Shudder.
The consolidation happening on Wall Street will leave even less people in control over even more money. One has to wonder if this wasn’t the name of the game in the first place. The incestuous relationship between the oligarchs we have become used to, is lately presenting its more ferocious side, showing that in their passionate love they are not afraid of devouring each other. And this mounting concentration of financial power is producing gorillas too large to measure in pounds.
Even without a degree in business law or economics, people should be starting to see the writing on the wall. Judging by the euphoria generated by both parties’ presidential candidates, I doubt that this awakening is taking place though. All this talk now by Obama & McCain about how they will reform the financial sector, introduce regulations and enforce them, is warm air, blown into the sails of their respective election ships on the swelling oceans of public fears and disillusionment. The crucial decisions in the landscape gardening project on Wall Street will be made by the same tweed suits who caused this mess in the first place, and the conditions imposed on the banking orgs will have loopholes big enough to push in 4 years the next election ship through.
As B pointed out, in terms of interest rates, the Fed has become irrelevant. In the current climate banks will be hording cash and offer interest rates way above the fed rate. Following a predestined path, the flight from falling equities into securer cash assets means interest rates will eventually come down again, allowing the businesses that will survive the current squeeze, bruised but alive, to slowly rebuild their balance sheets. Lower rates would also help to jump start the mangled housing sector, however for that to happen, house prices will have to drop further. Much further. Unrealistic expectations of asset values will need to be adjusted, not just in board rooms but also around kitchen tables.
A painful process, for sure. Financial stress causes marriages to break up, children being yelled at, depression and dispair. And so this financial melt down will bring about social hardships for the many caught up in this spider web of too closely related business interests. The anger and frustration will not be helped by the realisation that their perceived worth didn’t just disappear into thin air, but that it has been in scandalous fashion redistributed up the pyramid and the perpetrators are buying up foreclosed villas.
The real tragedy though becomes apparent when one puts the figures in context. While the Feds pours $80 billion into the bottomless pit Wall Street has become, people all over the world are starving to death, starvation that could be prevented by a fraction of that money:
UNITED NATIONS (AP) — The United Nations blamed the global food crisis Wednesday for a $3.4 billion global shortall in emergency humanitarian aid for 34 nations.
U.N. officials said that higher food and fuel costs, along with natural disasters and worsening conflicts, are making it more difficult to raise funds from donor nations, mostly Western governments.
“The donors will need to dig deep into their pockets to try to find that money,” said John Holmes, the U.N.’s humanitarian chief.
So far this year, $2.9 billion has been raised, representing about 46% of what’s needed to respond to the world’s most severe crises, Holmes said…
What a shame.
Posted by: Juan Moment | Sep 17 2008 9:20 utc | 24
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