Dangerous Unintended Consequences

This is an excerpt from a presentation made by Martin D. Weiss, Ph.D, of Weiss Research, to the National Press Club regarding the consequences of our government's recent, misguided, economic policies...

By Martin Weiss

Two years ago, when major banks announced multibillion-dollar losses in subprime mortgages, the world's central banks injected unprecedented amounts of cash into the financial markets.
But that was not enough.

Six months later, when Lehman Brothers and AIG fell, the U.S. Congress rushed to pass the TARP, the greatest bank bailout legislation of all time.

But as it turned out, that wasn't sufficient either.

Subsequently, in addition to the original goal of TARP, the U.S. government has loaned, invested, or committed $400 billion to nationalize the world's two largest mortgage companies ... $42 billion for the Big Three auto manufacturers ... $29 billion for Bear Stearns, $185 billion for AIG, and $350 billion for Citigroup ... $300 billion for the Federal Housing Administration Rescue Bill ... $87 billion to pay back JPMorgan Chase for bad Lehman Brothers' trades ... $200 billion in loans to banks under the Federal Reserve's Term Auction Facility (TAF) ... $50 billion to support short-term corporate IOUs held by money market mutual funds ... $500 billion to rescue various credit markets ... $620 billion in currency swaps for industrial nations ... $120 billion in swaps for emerging markets ... trillions to cover the FDIC's new, expanded bank deposit insurance, plus trillions more for other sweeping guarantees.

And it STILL wasn't enough.

If it had been enough, the Fed would not have felt compelled this week to announce its plan to buy $300 billion in long-term Treasury bonds, an additional $750 billion in agency mortgage backed securities, plus $100 billion more in Fannie Mae and Freddie Mac paper.

Total tally of government funds committed to date: Closing in on $13 trillion, or $1.15 trillion more than the tally just hours ago, when the body of this white paper was printed.

And yet, even that astronomical sum is still not enough!

Why not? Because of a series of very powerful reasons:

First, most of the money is being poured into a virtually bottomless pit. Even while Uncle Sam spends or lends hundreds of billions, the wealth destruction taking place at the household level in America is occurring in the trillions — $12.9 trillion vaporized in real estate, stocks, and other assets since the onset of the crisis, according to the Fed's latest Flow of Funds.

Second, most of the money from the government is still a promise, and even much of the disbursed funds have yet to reach their destination. Meanwhile, all of the wealth lost has already hit home — literally, in the household.

Third, the government has been, and is, greatly underestimating the magnitude of this debt crisis. Specifically,

The FDIC's "Problem List" of troubled banks includes only 252 institutions with assets of $159 billion. However, based on our analysis, a total of 1,568 banks and thrifts are at risk of failure with assets of $2.32 trillion due to weak capital, asset quality, earnings, and other factors. (The details are in Part I of our white paper, and the institutions are named in Appendix A.)

When Treasury officials first planned to provide TARP funds to Citigroup, they assumed it was among the strong institutions and that the funds would go primarily toward stabilizing the markets or the economy. But even before the check could be cut, they learned that the money would have to be for a very different purpose: an emergency injection of capital to prevent Citigroup's collapse. Based on our analysis, however, Citigroup is not alone. We could witness a similar outcome for JPMorgan Chase and other major banks. (See Part II of our white paper.)

AIG is big. But it, too, is not alone. Yes, in a February 26 memorandum, AIG made the case that its $2 trillion in credit default swaps (CDS) would have been the big event that could have caused a global collapse. And indeed, its counterparties alone have $36 trillion in assets. But AIG's CDS portfolio is just one of many: Citibank's portfolio has $2.9 trillion, almost a trillion more than AIG's at its peak. JPMorgan Chase has $9.2 trillion, or almost five times more than AIG. And globally, the Bank of International Settlements reports a total of $57.3 trillion in credit default swaps, more than 28 times larger than AIG's CDS portfolio.

Clearly, the money available to the U.S. government is too small for a crisis of these dimensions.

Fourth, but at the same time, the massive sums being committed by the U.S. government are also too much:

In the U.S. banking industry, shotgun mergers, buyouts, and bailouts are accomplishing little more than shifting their toxic assets like DDT up the food chain.

And the government's promises to buy up the toxic paper have done little more than encourage banks to hold on, piling up even bigger losses.

But the money spent or committed by the government so far is also too much for another, relatively less-known reason: Hidden in an obscure corner of the derivatives market is a unique credit default swap that virtually no one is talking about — contracts on the default of United States Treasury bonds. Quietly and without fanfare, a small but growing number of investors are not only thinking the unthinkable, they're actually spending money on it, bidding up the premiums on Treasury bond credit default swaps to 14 times their 2007 level. This is an early warning of the next big shoe to drop in the debt crisis — serious potential damage to the credit, credibility, and borrowing power of the United States Treasury.

This trend packs a powerful message — that there's no free lunch; that it's unreasonable to believe the U.S. government can bail out every failing giant with no consequences; and that, contrary to popular belief, even Uncle Sam must face his day of reckoning with creditors.