'Stock Market Mayhem and Bush’s Moral Swamp By Mike Whitney
“It’s scary out there---there’s blood on the streets” anonymous Wall Street trader
Last Wednesday, the Federal Reserve dropped its benchmark interest rate by 25 basis points to 4.5% citing ongoing weakness in the housing sector. As expected, the stock market rallied and the Dow Jones Industrial Average soared 137 points. Unfortunately, Bernanke’s “low interest” stardust wasn’t enough to buoy the markets through the rest of the week.
On Thursday, the hammer fell. The Dow plummeted 362 points in one afternoon on increasing fears of inflation, a slowdown in consumer spending, a steadily weakening dollar and persistent problems in the credit markets. By day’s end, the Fed was forced to dump another $41 into the banking system to forestall a major breakdown. This is the most money the Fed has pumped into the financial system since 9-11 and it shows how dire the situation really is.
Why do the banks need such a massive infusion of credit if they are as “rock solid” as Bernanke says?
As most people now realize, the mortgage industry is on life-support. Many of the ways that the banks were generating profits have vanished overnight. The “securitization” of debt (mortgages, car loans, credit card debt etc) has ground to a halt. What had been a booming multi-billion dollar per-year business is now a dwindling part of the banks’ revenues. Investors are steering clear of anything even remotely associated to real estate.
Additionally, the banks are holding an estimated $200 billion in mortgage-backed securities and derivatives for which there is currently no market. This is compounded by $350 billion in “off balance sheets” operations---which are collateralized with dodgy long-term mortgage-backed securities---that provide funding for “short-term” asset-backed commercial paper. ASCP has shriveled by $275 billion in the last 10 weeks leaving the banks with gargantuan liabilities. Bernanke was forced to add $41 billion to keep the banking system from slipping beneath the salty brine.
This shows how powerless the Fed really is when it comes to changing the overall direction of the markets. Sure, Bernanke and his buddies in the Plunge Protection Team can goose the market by buying-up futures and boosting the day’s results. But that’s just a short-term fix. In the long run, the Fed has less chance of stopping the market from correcting than it does of stopping a runaway truck by standing in its path. Besides, the Fed cannot purchase the banks bad investments (CDOs, MBSs, or CP) nor can it reflate the multi-trillion dollar the housing bubble. All it can do is provide more cheap credit and hope the problems go away.'
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