IMF predicts no end in sight to credit crisis

The International Monetary Fund (IMF) says there's no end in sight to the credit crisis gripping world financial markets.

The IMF has a particularly gloomy assessment of the US economy, and it came on the same day as the Bush administration revealed America's budget deficit will climb to a record high of more than half-a-Trillion dollars.

[Australian Broadcasting Corporation]

The Dodgy Asset behind the U.S. Dollar

Last Friday, after the market had closed, the FDIC shut down two more banks, First Heritage Bank and First National Bank. (The FDIC now operates like a stealth paramilitary unit, deploying its shock troops on the weekends.)

The new Fannie Mae and Freddie Mac bailout package that was passed into law on Saturday provides Paulson with $300 billion of taxpayer dollars to shore up the faltering mortgage behemoths.

In order to accomplish this, Congress increased the national debt by a whopping $800 billion sending it over the $10 trillion mark for the first time in history! (Naturally, Congress buried this little tidbit of information deep in the 600 pages of legislation.)

The Fed has already spent more than $300 billion to prop up the teetering banking system in the last year alone, plus buying the toxic bonds from Bear Stearns in the JP Morgan acquisition.

Now, the Treasury has been authorized by Congress to buy an "unlimited amount" of Fannie and Freddie shares at their own discretion. They are presently exchanging Fannie and Freddie securities for US Treasury's, which means that the dollar is now backed by dodgy mortgage-backed sludge (MBS) for which there is no market. According to Rep Ron Paul, "This is the asset (MBS) which now backs up our currency. An asset that no one else wants. If they were to dump these securities on the market today, the value of these stocks would go straight to 0. But that is literally the asset that is behind our currency. It is a very serious situation."

[Excerpts of an article by Mike Whitney]

Ross Perot: “We are running out of time”

Ross Perot is jumping back into the political fray, this time with a stern warning that the country better start paying attention to the national debt.

"Not since the Great Depression have we seen an economic crisis of the magnitude that we are facing today," he says.

The former presidential candidate has reemerged with a Web site spotlighting the soaring budget deficit: more than $9.3 trillion and growing.

He says the purpose of the site, which is not affiliated with any political party, is "to provide accurate information to every citizen about the serious economic problems facing our country."

[CNN]

Note: Mr. Perot points out that 9.3 trillion dollar bills placed end-to-end would reach the moon and back 1,900 times.

So How Bad is the Damage?

The demise of Indymac is expected to cost the FDIC around $8 billion of its meager $53 billion of reserves.

Four or five bank failures of equal size and the FDIC will be underwater, which is a serious problem since even conservative estimates expect bank failures to run into the hundreds.

But Indymac is small potatoes compared to the liabilities of the two mortgage behemoths, Fannie Mae and Freddie Mac. As the housing bubble continues to fizzle; Fannie and Freddie could face losses of $500 billion or more.

Investors are not charitable organizations

The United States has been financing itself by leaning heavily on foreigners, particularly China, Japan and the oil-rich nations of the Persian Gulf.

Obviously, this is going to come to an end. Foreigners are not charitable organizations, and they're going to demand that we pay them back.

No single country owning large amounts of dollar-based investments is inclined to dump them abruptly; nobody aims to start a panic. But fears have begun to grow that one day a country may get spooked that another is about to dump its dollars--and that could trigger pre-emptive panic selling.

The U.S. government offers its rescue of the Fannie Mae and Freddie Mac mortgage companies, and foreigners keep stocking the government's coffers. But all the while, the debt mounts along with the costs of an ultimate day of reckoning. Debate grows about the wisdom of leaning on foreign credit, and about how much longer Americans will retain the privilege of spending and investing money that isn't really theirs.

[Excerpt of an article by Peter S. Goodman, NY Times]

The unsettling void of the U.S. economy

To calm markets, the government last weekend hurriedly put together a rescue package for Fannie and Freddie that, if used, could cost as much as $300 billion. The urgent need for a rescue--together with another round of billion-dollar write-offs on Wall Street--has unnerved economists and investors.

"I was a relative optimist, but I've certainly become more pessimistic," said Alan S. Blinder, an economist at Princeton, and a former vice chairman of the board of governors at the Federal Reserve. "The financial system looks substantially worse now than it did a month ago."

Mr. Blinder added, this is like the Great Depression. "We haven't seen this kind of travail in the financial markets since the 1930s," he said.

More than two years ago, Nouriel Roubini, an economist at the Stern School of Business at New York University, said that the housing bubble would give way to a financial crisis and a recession. He was widely dismissed as an attention-seeking Chicken Little. Now, Mr. Roubini says the worst is yet to come, because the account-squaring has so far been confined mostly to bad mortgages, leaving other areas remaining--credit cards, auto loans, corporate and municipal debt. “We're not even a third of the way there."

Where will the banks raise the huge sums needed to replenish the capital they have apparently lost? And what will happen if they cannot? The answers to these questions are unknown, an unsettling void that holds much of the economy at a standstill.

[Excerpt of an article by Peter S. Goodman, NY Times]

US faces global funding crisis

Merrill Lynch has warned that the United States could face a foreign "financing crisis" within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.

Merrill Lynch said foreign governments had added $241 billion of US agency debt over the past year alone. China holds around $400bn, Russia $150bn and Saudi Arabia and other Gulf states at least $200bn.

Brian Bethune, chief financial economist at Global Insight, said the US Treasury had two or three days to put real money behind its rescue plan for Fannie and Freddie or face a dangerous crisis that could spiral out of control.

Fannie and Freddie - the world's two biggest financial institutions - make up almost half the $12 trillion US mortgage industry. But that understates their vital importance at this juncture. They are now serving as lender of last resort to the housing market, providing 80pc of all new home loans.

Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt - as well as other US "government-sponsored enterprises" - is now in foreign hands. The great unknown is whether foreign patience will snap as losses mount and the dollar slides.

[The Telegraph]

US inflation rate at 17-year high

This past month, US inflation accelerated at its fastest pace in 17 years, official figures have shown, driven higher by surging energy prices

In his second day of congressional testimony on Wednesday, Fed boss Ben Bernanke said inflation was too high and it was a key objective for the central bank to bring it down. Many analysts now believe that the central bank may have to leave borrowing costs on hold, or even increase them, as it tries to steer a faltering economy through turbulent times.

Gary Thayer, from Wachovia Securities, says that the Fed is facing a tricky balancing act. "This increases concern that the Fed is not going to be able to lower interest rates if the economy remains weak."

But he added: "And as long as the economy remains weak, it will be hard for the Fed to raise rates to fight inflation."

[BBC News]

Financial Collapse Edging Closer?

The financial crisis in the United States and worldwide entered a new phase this week, as Fannie Mae and Freddie Mac, the two huge US home-loan institutions, began what appears to be a "death spiral" similar to that which claimed Bear Stearns four months ago.

In 1933, about a quarter of US banks failed, [but things were more solid] because US banks in the 1920s had been relatively conservative in their lending, with many banks requiring a 50% down payment for home mortgage loans, for example. The main problem in 1932-33 was quite simply liquidity; the Fed failed to supply adequate reserves to the banking system, so crises of confidence in individual banks led to panic withdrawals of deposits that caused the banks themselves to fail.

This time around, the problem is the opposite.

Fannie and Freddie are probably toast. Federal Reserve Board chairman Ben Bernanke's statement that the two companies can discount paper with the Fed may prolong the inevitable, but also increases its likely huge cost to taxpayers.

A total collapse of the US financial system, while not inevitable, is a contingency which should now be planned for.

[Excerpt of an article by Martin Hutchinson, a retired international merchant banker, writing in the Asia Times]

IndyMac bank second largest bank failure in US history

The Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision (OTS) “took control of Pasadena-based IndyMac Bank on Friday in what regulators called the second-largest bank failure in U.S. history.” The bank has succumbed to “huge losses from defaulted mortgages made at the height of the housing boom”:

As the bank was shuttering offices and laying off employees nervous … depositors were pulling out $100 million a day. The bank’s stock price had plummeted to less than $1 as analysts predicted the company’s imminent demise.

The takeover of IndyMac came amid rampant speculation that the federal government would also have to take over lenders Fannie Mae and Freddie Mac, which together stand behind almost half of the nation’s mortgage debt.

Meanwhile Forbes reports that the FDIC is monitoring 90 institutions with assets of $26 billion that it has identified as troubled.

Greenspan confirms U.S. economy on brink of extended recession

Former U.S. Federal Reserve Chairman Alan Greenspan, when asked if the U.S. economy was in recession, said: "We are on the brink".

"A rebound at this stage is not something I think is in the immediate outlook," he added.

[Reuters]

The Recession is only just beginning

This will be a different kind of recession -- a recession with an overlay of inflation. That combo puts the Federal Reserve in a Catch-22 -- whatever it does to solve one problem only makes the other worse.

[For the past year] we've seen a fairly consistent pattern to the economic mood swings. Every three months or so, there's a round of bad news about housing, followed by warnings of more bank write-offs and then a string of disappointing corporate earnings reports. Eventually, things stabilize and there are hints that the worst may be behind us. Stocks regain some of their lost ground, bonds fall and then -- bam -- the whole cycle starts again.

The last hope for a second-half rebound began to fade earlier this month when Lehman Brothers reported that it wasn't as immune to the credit-market downturn as it had led everyone to believe. It could be the next Bear Stearns. Since then, there has been a steady drumbeat of worrisome news from nearly every sector of the economy.

Like the rain-swollen waters of the Mississippi River, this sudden surge of downbeat news has now overflowed the banks of economic policy and broken through the levees of consumer and investor confidence. At this point, there's not much to do but flee to safety, rescue those in trouble and let nature take its course. And don't let anyone fool you: It will be a while before things return to normal.

[Excerpt of an article by Steven Pearlstein, Washington Post]