When Henry Paulson agreed to leave his job as chairman of the powerful Wall Street investment bank, Goldman Sachs to go to Washington as Treasury Secretary in 2006 he demanded extraordinary powers as de facto economic czar. He got it.
Paulson is also head of the President’s Working Group on Financial Markets — the secretary of the treasury and the chairmen of the Federal Reserve Board, the Securities and Exchange Commission and the Commodity Futures Trading Commission. The Working Group is the financial world’s equivalent of the Pentagon war room. Paulson, not Fed chairman Bernanke, is the person running the Administration’s crisis management. And his recent actions indicate he has lost control as the snowballing problems from the semi -government mortgage companies Freddie Mac and Fannie Mae to the collapse of the multi-trillion dollar market in Asset Backed Securities (ABS) to the real economy are compounding into the worst crisis since the 1930’s Great Depression.
The US banking system is sound
In an eerie echo of President Herbert Hoover in 1932, during a Presidential campaign against Roosevelt, following the stock market crash and collapse of numerous smaller banks, Paulson recently appeared on national TV to declare “our banking system is a safe and sound one.” He added that the list of “troubled” banks “is a very manageable situation.” In fact what he did not say was that the US bank deposit insurance fund, the Federal Deposit Insurance Corporation (FDIC) has a list of problem banks that numbers 90. Not included on that list are banks such as Citigroup, until recently the largest bank in the world.
The statement is hardly reassuring. The California savings bank, IndyMac Bank which was declared insolvent a month ago was not on the FDIC list a week before it collapsed. The reality is the crisis created by “securitizing” millions of home mortgages into new financial instruments and selling the packages to pension funds and investors is unfolding like a snowball rolling down the Swiss Alps.
Indication of the lack of control is the statement just weeks ago by Paulson that “financial institutions must be allowed to fail.” That was two weeks before Paulson went to Congress to ask for “Congressional authority to buy unlimited stakes in and lend to Fannie Mae and Freddie Mac.” As I noted in my recent piece, Financial Tsunami: The Next Big Wave is Breaking: Fannie Mae Freddie Mac and US Mortgage Debt , those two private companies insured some $6 trillion worth of home mortgages, half the entire US mortgage debt. Paulson defended the request by calling Freddie Mac and Fannie Mae “the only functioning part of the home loan market.”
That comes back to the statement about a “sound banking system”. Can we have a sound banking system where the only functioning part is literally insolvent―its debts greater than its assets?
It is well known on Wall Street that some of the largest financial institutions have huge undeclared problems with Asset Backed Securities they have valued far above their worth to make their books look better than they are. The names Citigroup, Lehman Bros., Morgan Stanley, even Paulson’s old firm, Goldman Sachs and of course the inventor of sub-prime mortgage securitization, Merrill Lynch, all hold a huge percentage of what are called Level Three assets, these being assets where no one is willing to buy but the bank declares their worth based on “fantasy.” In short the value of those core financial institutions of the US financial system is massively overvalued compared with their value were they forced to sell into the open market today. In a sobering aside, readers should not expect any serious economic remedies for the crisis from a President Barack Obama. Obama’s National Campaign Finance Chairman is Chicago real estate billionaire, Penny Pritzker, who is heir to among other things the Hyatt Hotels. It was Pritzker together with Merrill Lynch ten years ago who first developed the model for securitizing “sub-prime” real estate, the trigger for the current Financial Tsunami crisis.
Already Citigroup has been forced to go to Dubai hat in hand and ask for billions in cash. After it announced it would not need more capital. Now Citigroup just announced plans to sell some $500 billion more assets to raise funds. Is Citigroup really solvent is the question sober investors are asking. Similarly Merrill Lynch raised $6.6 billion from Kuwait Mizuho, stated it was fine and weeks later had to raise still more capital. Morgan Stanley sold a 10% share of the company to China International Corp.
The real economy contracting rapidly
Behind the reassuring statements from Paulson and others that the “worst is over” the reality of the credit collapse since August 2007 is a deepening economic contraction which I have said several times in this space will surpass the Great Depression of the 1929-1938 period. A good friend who is an unemployed homebuilder in a prosperous part of Arizona just sent me the following list of US department retail store closures. It is worth noting that over 70% of the US GDP is consumer spending and that the entire Federal Reserve strategy of Alan Greenspan after the March 2000 collapse of the stock market bubble, was to bring US interest rates to their lowest levels since the 1930’s in order to stimulate consumer spending on credit, i.e. debt, to avoid “recession.” Note the scale of the following store closings across America in recent weeks