Let sleeping shadow banking systems lie

By J Saft
March 6, 2009

James Saft Great Debate — James Saft is a Reuters columnist. The opinions expressed are his own —

Rather than vainly trying to refloat the shadow banking system, the U.S. would be better off grappling with the inevitable ultimate solution — debt destruction and inflation.

The common denominator of policies like the Term Asset-Backed Loan Facility (TALF) that was detailed on Tuesday, is that they try to solve fundamental problems with indebtedness by attempting to float asset prices high enough that they are back in proportion with the debt.

Even more, they use the same structures that worked out so poorly — highly levered hedge fund like vehicles and securitisation — but this time substitute government funding and leaves the taxpayer as main bag-holder if the deals go bad.

With up to $1 trillion, the TALF is designed to re-start parts of the securitization market such as auto, business and student loans. This followed the plan to avoid foreclosures and further house price falls by cutting borrowers, many of whom made silly borrowing decisions, a break on their interest rates.

Next up: a public-private plan to buy up toxic legacy assets from banks, which should be detailed in the next two weeks. Again, that program will provide government money at sub-market rates to investors to entice them to pay more than the market price for assets that would otherwise sink many banks.

The higher the leverage supplied the higher the price hedge funds and other investors will pay for doubtful assets. After all, like a Florida condo flipper, if the asset declines in value they can just walk away and throw the metaphorical keys at the Federal Reserve and U.S. Treasury.

“We want to make sure that the prices of the assets that are purchased reflect true market values that are not overpaid. So the idea between the public-private partnership would be that there would be both public and private money involved and that the pricing decisions would be made by private-sector specialists, not by public bureaucrats,” Fed Chairman Ben Bernanke told Congress on Tuesday.

“If the government is willing to provide longer-term lending, or leverage, there are many investors who presumably would be willing to buy under those circumstances who are unwilling to buy without the credit, without the lending they need to finance those purchases.”

I simply cannot reconcile the first part of that statement with the second. What do we mean by “market values” in a situation where the government provides financing not otherwise available? Vary the leverage and achieve any price you like.


The TALF is slightly more defensible. There is a market failure when reasonably good credits can’t raise money under any circumstances. But before we try to re-start securitization and the shadow banking system, let’s recall what the problems were in the first place. For one thing the TALF relies upon imprimaturs from the credit ratings agencies which have been found wanting. That’s not yet changed, but government participation simply papers it over.

Even the obsession with banks almost seems beside the point.

“You won’t revive the economy through debt,” said Albert Edwards, global strategist in London at Societe Generale.

“Banks aren’t the problem, they are a symptom of the problem.”

The problem is that asset prices are out of line with their ability to generate cash flow. Falling prices do impose a risk premium but the real issue, for stocks or for houses, is that their prices are not in the proper proportion to the debts they carry and to their ability to generate cash. That happened in part because of the shadow banking system and was a mistake.

So, what’s the implication? Some debt will be repaid but a lot will just be destroyed via default. An organized write-down seems impossible. That will be a huge problem for the banking system and the country, and you can understand why the government does not wish to meet it head on.

University of Oregon economics professor Tim Duy thinks the U.S. will ultimately end its romance with financial engineering and get down to working through unsupportable debt the old-fashioned way — inflation.

“And therein lies the key to predicting when the Fed shifts gears; When Bernanke abandons the notion that proper credit market functioning is alone sufficient to restore housing values (asset values more generally) to their former glory and support acceptable growth,” Duy writes.

“At that point, the Fed will again consider the wisdom of what it has defined as quantitative easing, an expansion of the balance sheet via a deliberate expansion of liabilities.”

That is a dangerous and difficult to govern process, and the U.S. shows every sign of being willing to pay a very high price to avoid it.

But ultimately, the price will be too great and we will have to inflate and default in some mixture.

— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. —


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I think the catastrophic extent of these losses is just beginning to be realized. I wonder why smaller banks who are doing well, are also being forced to accept government funding. I am extremely concerned as to the recent revelation that the FDIC is running out of funding, citicorp is a penny stock, and BOA is $3 a share after receiving tens of billions. I want to say something to people: you need to put money in multiple accounts, including small banks, credit unions, and the cookie jar. Something very,very serious is happening here.

10 million homeless, 30 million on food stamps, former corporate behemoths gone broke, criminal CEO’s the rule, not the exception, real unemployment more than 10%
and Europe in a protective crouch.

The American people need to get serious. Talk to your family and make a plan. Save your money, because the ship has hit the iceberg, and the only thing that is going to keep people afloat is cold, hard cash.

Save your money because I am afraid the crash is coming.

Posted by phoenix1 | Report as abusive

A typically trenchant analysis. My thanks. Just as banks and the shadow banking system are symptomatic, the ongoing state of denial is symptomatic. Whether by conscious choice or simply driven by the interplay of denial psychology with the facts, I agree that the only ‘solution’ will be some combination of default and inflation. We are, at this point, still insistent on attempts to deny the realities.
It would be far better if there were a willingness at the policy level to accept and address that fact, but the fact that we haven’t yet reached that point is also, I think, symptomatic.
To quote the great economist Howard the Duck: ‘This does not bode well.’

Posted by Atomik Weasel | Report as abusive

Excellent article. It’s encouraging to see that at least some people understand the problems as they are. Spending taxpayers’ money on cosmetic solutions would just make it harder to recover.

Posted by YR | Report as abusive

In Leviticus (Bible/Torah) chapter 25, there was an injunction to return homes which had become mortgaged every 50 years (year of Jubilee). There was a forgiveness of debt required in the nation.

RE:” “You won’t revive the economy through debt,” said Albert Edwards, global strategist in London at Societe Generale.”

“Some debt will be repaid but a lot will just be destroyed via default.”

Debt forgiveness is the lifeblood needed to regain a stable economy. If consumers who are holding assets by which they will default, and banks need to unload undervalued assets, forgive the debt, give the homes to the occupants and let them free up cash for discretionary spending which will generate sales in local businesses and sales taxes for local and state governments.

It is criminal that the very banks who have received massive bailouts because they are functionally bankrupt because of predatory lending, should not turn and forgive/release their victims.

Posted by dennis shea | Report as abusive

History will mark this down as a problem linked to housing prices. Yet this is a global problem. So again we have more people rewriting history – essentially as it unfolds – probably to appease those who do not understand the underpinnings of the crisis. Others will say that consumers are discouraged from spending – despite the fact they spend freely even much more than their income. So I think the idea is that we can emerge from the slump by writing off debts. But a debt for one person is an asset for somebody else. So the guy who owes can spend more, but the guy who is owed can spend less. To me that means there is no net change, except that the lender will never want to provide funds in the future. If we print off money in exchange for IOUs, again the sides are balanced. Increasing the money supply worked to the extent that certain stakeholders did not require the funds.

Posted by Don | Report as abusive


“But ultimately, the price will be too great and we will have to inflate and default in some mixture.”

Inevitably this thing will not end with government funding. Taxpayers will be willingly or unwillingly become the funders of last resort.
I do not envy the politicians that will have to explain to the public that the losses will have to be covered by the taxpayers, so sorry, and by the way,it is very unfortunate you have already lost their savings earlier in the process due to quantative easing.We are so sorry.
Looks and feels like a catch22. Sounds like “prepare for impact”.

Posted by Jos Beije | Report as abusive

Once again Mr. Seft does well. I do business with a regional bank that covers maybe three counties in a State. They’re not in any trouble.

Posted by Andrew Franks | Report as abusive

I am afraid that “cold hard cash” might not even make it, although so far it might have been the best. This story will have turns and twists nobody today can accurately anticipate. But if we speculate what might lie ahead, I suspect foul play will be applied here too, and your cold hard cash might end up as warm soft paper!
Be prepared for bank holidays, loss of bank deposits, freezing of accounts, money substitutions, confiscation and whatever else you can think of. They are all possible, and can make a mockery of your education, savings and pension.
The governments around the world are starting to panic and the people are not far behind. When fear prevails strange things can happen and normal rules go out the door.
We are dealing with the largest problem in living memory and that is only starting to be acknowledged. Apart from a financial problem, which we see at the moment, it could well morph into something more sinister.
If ever there was a time to be nimble and resourceful, now is it! Hope for the best but be prepared for something, well – ugly.

Posted by g kaiser | Report as abusive

I am starting to hate the words “quantitative easing”. Never, ever, ever underestimate the danger of inflation morphing into hyperinflation. And hyperinflation… well, it always leads to war.
Why save if government will make money saved relatively worthless through inflation?

Posted by eli | Report as abusive

This is the key issue all over the world that will affect everything…. Setting the value of goods and assets.

“The problem is that asset prices are out of line with their ability to generate cash flow. Falling prices do impose a risk premium but the real issue, for stocks or for houses, is that their prices are not in the proper proportion to the debts they carry and to their ability to generate cash.”

Extremely good remark

Santiago Cardoso

Posted by Santiago Cardoso | Report as abusive

How about we skip inflation and just make everyone default and go bankrupt? Restore sound money and after a short (maybe a year long) series of job losses and poor economic performance we will once again be a booming country.

Posted by Rob Green | Report as abusive

Can’t believe their talking about inflation as a solution again… I still have some stamps from Germany that my grandfather gave me. Don’t go there!!!

Posted by Weimar Mugabe | Report as abusive

Mr Saft correctly restates John Kemp’s earlier piece which stated the basic problem: the amount of debt in the US is more than the GDP can support, and there are only two ways to resolve, either default/restructure (which the US Govt, unlike emerging countries will not do) or repay with inflated currency (and hope creditors accept USD instead of asking for yen or gold).

If (1) the TALF will really be used to finance AAA ABS, (2)ratings agencies perform their due diligence rather than blindly relying on tapes of data provided on the investment bankers and perhaps most importantly, (3) users of TALF as well as investment bankers who structure the ABS are required to adopt compensation plans that pays incentive comp to them only when the ABS pay out or mature — then the TALF may will play its role at allocating debt capital in an efficient manner as it will have addressed the main problems that got us here in the first place.

Problem with using inflation to get us out of this jam is it may get out of control and lead to hyperinflation which is worse than a depression, at least to those that have been conservative and are net savers not borrowers.

A little inflation (under 10%) won’t be too bad, but the Govt should not rely solely on inflation, it should let defaults, failures and foreclosures run their course to squeeze some of the leverage out of the system.

Posted by Doublea | Report as abusive

I agree, an asset only has value in proportion to the income it produces. In the hands of the banks and the government assets produce very little income therefore have very little worth. Trying to put artificial values on these toxic assets and encouraging investors to buy them at inflated prices will just delay the recovery. It may make more sense to auction them off to the public and see what the market will bring. The banks may take an immediate hit but the economy will benefit from this move in a shorter time.
The American people are wonderful at taking assets that are of little worth to banks and government and producing something of great value out of them. The examples of this are numerous throughout our history. Give the American people a dream and the freedom to work it and the world will be amazed at what we can do.

Posted by Craig Coal | Report as abusive

Another great article, thank you.
Take a look at the agenda for the London G20 in April. Aside from various side shows, the macro-economic area is being cast as:
(1) fiscal – coordinating the big spend up
(2)monetary – quantitative easing
Nothing about the underlying asset price problem, or the question of who is going to buy the massive amounts of debt that governments will be issuing, or the consequent currency issues, or the failure of the central bank model of the past 20 years.
So, lots of noise, no worthwhile action. Please, is there another planet with better fundamentals and leadership?

Posted by Simon Smelt | Report as abusive


1. the credit markets are actually working correctly right now – banks are insolvent since they lent out much more money than they had or that can be repaid.

2. the bailouts only attempt to maintain the house of cards, or slow its collapse.

3. its not realistic to assume that the value of the underlying assets will come into line with their debt obligations before the end of the century – and the US will run out of money/borrowing power before then.

i suggest shovel-ready infrastructure spending and spending on health, education, welfare of minors only. let everything else move into the bankruptcy courts.

Posted by rbsjr | Report as abusive

Instead of patronizing or subsidizing wise world leaders should just give back what people already owned.
Capital Dynamics:

I have been playing with some analytical insights to figure out the underlying functioning of the global financial meltdown as follow:

Lost and Found Conceptions:
Many objects lost can be found so that institutions may have a department to handle lost objects returning them to their owners.

Money can be lost on two ways in the financial market.

1. Lost by transfer.
A person loses his wallet but somebody finding it can spend the money keeping it cycling in the economy.

2. Lost by destruction.
A person loses his wallet in a fire and the money is burned being out of circulation definitively.

Last year only in the US the stock exchange lost by destruction 7 trillion dollars that is considered out of circulation forever. This economic crisis that started in the US and spread globally may have contributed to vanish around 15 trillion dollars worldwide. UN predicted a consequence of 50 million jobs to shed due to this economic downturn.

The approved stimulus package of less than a trillion dollars may provide some sort of relief to a crisis that destroyed about 7 trillions in the US. However the amount destroyed in one year in the stock exchange takes around 5 to 10 years to be created.

Mr. Obama, when a person loses his wallet in a fire it becomes a challenge to claim any loss because there is no way to provide any information about the content lost. The Stock exchange system tracks the stocks allowing losses be reimbursed to owners. It is a good deed retuning money that was meant to pay retirement or college fees, or even charity institutions endowments.

Why to do it?
There are 50 million jobs losses to prevent ensuring a better leadership to the world. A simple smart management in the economic system could avoid such catastrophe.

Transforming stocks to fixed rate investment could give all governments a strong tool to restore destroyed capital back to previous values curbing destructive power from fears. Investors would accept a deal to transform their stock to the purchasing value plus interest rates (2% a year?) with a minimum moratorium (2 year?} for the companies to allow programmed withdrawing.

There is a very fair reasoning since the capital destroyed existed previously originating from many sound sources. Good part of healthy money can be restored to its integrity curbing a worldwide damaging financial crisis worsened by combined effect of fears.

I estimate that there was a general loss around 30% of stocks worldwide; it means that money in such stock applications should be around 50 trillion dollars which allowed about 15 trillions to be destroyed and harm the global economic system.

I believe that 50% to 70% of money lost in the stock can be recovered back as a fixed rate investment meaning 3 to 5 trillion dollars returning to the economy in the US to the purchasing values plus interest rates of the period.

Converting stocks to fixed rate investment can be a permanent tool to prevent future economic collapses and to reduce the size and importance of stock exchange in the economy. Companies would sell stock and ensure that at least fixed rates their stocks should guarantee investors in case of downturns. When a company degrades its performance, its stocks start becoming fix rate investments preventing a further degradation by fears in the free offer-demand rule.

If investors know that their money can be recovered at least at the levels of fixed rate investments, they would not become so eager to retreat from the stock market from falling stocks. In general the stock exchange should compensate at least to the level of fixed rates. This puts a tricky break on falling trends avoiding worsening situations.

What should it be called?
Stock Rescue System:
Governments will make Laws to ensuring that companies selling stocks would offer options to transform stocks to fix rates investments. This amendment would protect against spreading fears and any sort of retreat that spoil parties or overall functioning of the economy. Fixed rates could become a capital investment for withdrawing on investor interest.

There is a strong coherence in nature functioning stating that any single problem can accept or admit many sorts of solutions with variable results. Lost and Found department works pretty well on many places returning lost objects because they were not destroyed and were found. It seems that some money lost in the financial crisis can be tracked back to due owners and returned on a safe fashion to avoid further consequences to the global economy. Also, a permanent Stock Rescue Amendment should provide a way to prevent such situation take place again bringing a more stable economic functioning worldwide.

We are learning that a subtle huge destruction of capital in a short span can be very damaging to the economic system. It is not hard to assume that intelligent humans can organize better their way of handling their common issues.

Whenever wisdom is applied sound results should benefit many from a more coherent outcome

Posted by Elson Silva, PhD | Report as abusive

Mars has better fundamentals and leadership.

Posted by phoenix1 | Report as abusive

There is a huge pile of something at NBC/Universal/GE that looks shovel ready to me.

Posted by phoenix1 | Report as abusive

i don’t believe we should be arguing without a strong basis of facts

Posted by john | Report as abusive

Excellent analysis. I would like, however, to ask the following question – to Mr. Saft, his colleagues and readers. For every house being sold to a more or less solvent buyer, money have been paid to a seller. Those who sold houses during the boom (both individuals and companies) got their money – in fact, they got great prices. One would reasonably expect these money to be available for investment and consumption, to circulate and provide “stimulus” to the economy. Instead all this capital seems to have disappeared from the economy altogether. How come? All these tremendous losses that banks face as a result of the subprime crisis, all this insolvency represents money that have been paid to individuals and companies. Yet we hear nothing about these individuals and companies. What are they doing with their money? Is it reasonable to suspect that most of this capital is used exclusively for the purpose of speculating the housing market (stock market, commodities market, currency market etc.), i.e. just for making quick profits, and that it never gets invested in the real economy? I think there might be a topic worth of Mr. Saft’s plume.

Posted by Andre | Report as abusive

The numbers of people losing their jobs is a tragedy, the numbers of people being forced to use social safety programs is a tragedy. Destruction of wealth derived from and based on purely speculative instruments, or a contraction of the financial system is not a tragedy. The hand wringing and hype over most of this crisis, and the public policy in reaction to it have been largely aimed at a world which no longer exists, nor can it. Policy needs to set it’s sights on a reasonable level of economic activity, rather than trying to beef to beef up the economy to levels which were sustained by unreasonable leveraging and wanton speculation. To try to push the economy up to pre crisis levels is a waste of limited resources.

Posted by ERhoades | Report as abusive

Having grown up in a small town that worked on a cash and carry basis, I would like to thank Wall Street and bankers for improving our lives with investment and credit.

Posted by Ken | Report as abusive

Many years ago, one needed an insurable interest to buy insurance. When did they drop that?

Years ago, a contract was everything, and fixed. You couldn’t change the terms after the fact. When did they change that?

Years ago, people took out a mortgage, the bank held it, and assumed the risk.

Years ago, Wall Street sold stocks and bonds to raise capital.

Years ago, people used credit in a crunch.

Posted by Ken | Report as abusive

I’m a bit confused. How does ANY entity cause inflation to occur? My view of inflation is that is highly unpredictable. Economists say they understand what causes it, but my view is that, being that economics has always been “the dismal science”, no one really knows what causes it. The idea that the government will have to inflate it’s way out certainly makes sense, but how does one know with any certainty that it will actually occur? Am I stupid? Another thing: Everyone talks about all the debt out there, but you can’t have too much debt without also having too much money. My view is that the main cause of this whole mess was allowing the money supply to get out of control. Too much money, thus too much money to lend, so lets lend it to anybody, even people who can never pay it back. All the excess money obviously also leads to excess asset speculation. So how come with all the excess money haven’t we also seen excess inflation? Well, we have with assets, but not with costs of most goods and services.

Posted by JJay | Report as abusive

There is only one thing that causes inflation. It is the increase in the money supply. The US government does not issue currency anymore (the privately owned Federal Reserve Corporation usurped the government in 1913 taking away this constitutional arrangement). It is this private corporation that controls the money supply and has engineered the financial crisis through money manipulation. When asset prices hit the bottom then the wealthy families that own the federal reserve will buy up US infrastructure at low prices with their hoarded cash. Look up Ben Bernanke’s speech on Milton Friedman’s birthday where he admits that the federal reserve caused the great depression of the 1930s. Debt is not really destroyed but rather it is a claim on tangible assets. When the debtor cannot pay then the banking cartel takes their physical assets. So the bank gives us worthless paper, then tightens the money supply, and finally buys up the real economy. Thomas Jefferson and many other warned of this phenomenon but it is too late in the US since the banking cartel also owns the US media.

Posted by jay | Report as abusive

This analysis is right on the money.

The Great Tragedy unfolding now is that millions and millions are being rendered homeless and destitute by the irresponsibility of financial institutions deemed too big to fail by our government.

But the Greatest Tragedy by far is accepting that these institutions are too big to fail. We the People have become hostage to these institutions and are now delivering up to them the blood, sweat, and tears of generations to come.

This is the greatest irresponsibility of all, and the one history will remember us for.

Posted by Mike Belcher | Report as abusive

Thank you James for another pithy analysis of the problem – you are spot on, particularly with your comment that: “The problem is that asset prices are out of line with their ability to generate cash flow… [house] prices are not in the proper proportion to the debts they carry and to their ability to generate cash.”

When I told people a few years ago (as I was selling my London home) that property was overvalued, they asked me how I knew and I simply pointed to the disparity between the price and the rental value. That disparity still stands – in fact recent falls in house prices have not closed the gap in the UK because a glut of rental properties is driving down rental yields – until the two are back in rough alignment the housing market will continue to suffer.

Kind regards
Father Ignatius Brown.

Posted by Father Ignatius Brown | Report as abusive

Do you think that the purchase of the toxic assets alone is a problem? In exchange for equity, would that have helped? A more structured bailout focused on just the toxic assets would have sparked lending, would it not – down the road a piece say? If they didn’t have the toxic assets could they have begun to cover they hedges if refinanced?

Posted by Wesley | Report as abusive

Several things need to happen to get credit going and they will be ugly and take time. First, housing prices were inflated by too much easy credit so the housing inventory will have to be repriced by the market for a world with more rational credit policies, like lending only to people with credit. There needs to be regulation and oversight to insure this is really happening and there won’t be any backsliding. Then the credit rating agencies will have to put realistic ratings on securities and, the hard part, convince investors that they are really legitimate this time. www.santaclaussyndrome.com

Posted by R. Lamar Smith, CPA | Report as abusive

As one of the talking heads said during the bailout discussions last fall, “one dollar was doing the work of thirty”. In other words that capital never actually existed. The magic credit money machine was smoke and mirrors; one mirror broke and 15 dollars was shown to be smoke.

Posted by Cordell | Report as abusive

The comment by Mr. Saft that “The problem is that asset prices are out of line with their ability to generate cash flow. Falling prices do impose a risk premium but the real issue, for stocks or for houses, is that their prices are not in the proper proportion to the debts they carry and to their ability to generate cash.” is also just a symptom.

It is a symptom of a fraudulent economic system that rewards only one thing. Speculation. One cheap trick after the other is what constitutes our economic system. Make money without producing anything. Rating agencies? A sad joke of corruption and inside dealing. I wonder what an investigation of those outfits would yield.

The fact is, when the Fed can create money, and the Government can spend unproductively, it creates inflation because the actual value created by work, capital and initiative is being siphoned off to the speculators. The fact is, housing was not keeping up with inflation throughout the 90s in many places. So it suddenly jumped in value which was simply a response to the distortions created by corruption paid for by the ill-gotten gains of speculation, unreasonable amounts of unproductive government spending and “pumping liquidity” by the Fed. If we want to fix this we need a new economic system. One that is rational and recognizes the fertile ground for non-productive economic activities created by our current system.

I suggest we nationalize the Fed. Eliminate all federal taxes. Pay for the costs of government by inflating the currency. Make this an open debate as to how much we are willing to reduce our wealth in return for the programs of government. At least this would be honest.

Posted by Jonathan Cole | Report as abusive

Why are “asset prices are out of line with their ability to generate cash flow.”?

Because of securitization, a runaway securitization.

Why did securitization got out of control?

A combination 2 things:
1) A deep belief in the power of financial ‘engineering’, i.e. mathematical tricks on high leverages. The shadow banking people believes in its ability to create real wealth. Well, it has, for the shadow people, for a while, when they racked in untold billions in compensation. But it blew up economies. When the ‘quant’ people add things up they will confirm that no real wealth has been created – it just transfers real wealth created by other means in the economy to paper wealth in Wall Street.

2) There is a a deep belief in market fundamentalism, which forms the basis for extreme de-regulation. Perhaps it was the great desire to implement extreme financial engineerings that propelled extreme de-regulations, rather than an innocent belief in an ideology.

Both, of course, are proven to be not only false, but massively destructively fault.

But the high priests of Wall Street still cannot bring themselves into believing it. Thus we still have Guithner heroic attempts to revive the system. Pump more debt onto worthless debt, hoping the leverage mechanics will fix itself. His attempt will fail, representing the final destruction of a financial paradigm. After which America must decide how to create wealth to replace what’s lost. I suggest it should consider real stuff instead of artificial money.

Posted by TomK | Report as abusive

Mr Saft – excellent article that creates discussion direly needed given maximum media misunderstandings (not at ThomsonReuters of course!)

The use of the Fed’s balance sheet is misunderstood.

Basically the Fed is currently replacing the funding supplied by the smaller net lending banks in fed funds and the securitized lending (repo) funding from the Fidelitys, Federateds, Pimcos etc.

The Fed actually has generated much of the funding using the excess reserves held at the Fed (that they now pay interest on) that are the result of the fact that the aforementioned banks/funds won’t lend. The reason that this is brilliant and not dangerous (inflationary) – yet – is because the growth of the Fed’s balance sheet is in Monetary Base, not M1 plus – the reason is the money multiplier not really being implemented without bank lending.

The reason the TALF is going to be very successful is because the Fed will be dealing with hedge funds as well as banks – thus in a prime brokerage role. This move is dramatic as it will open up hedge fund balance sheets to buy up other debt assets currently clogging the system and in front of the aforementioned real money funds that are paralyzed with fright (which will prompt them to come buying/funding).

And ultimately hedge funds will be along with private equity and real money accounts will buy the toxic bank assets as the layers of credit markets thaw – Tudor has assembled a powerful toxic asset buying team as well Paulson and Co that has over $1 Bln (before leverage)earmarked for this very trade, as well as many others.

Thus leverage (from the Fed, hedge funds, PE etc) will play a role in solving and not just causing this crisis. Eventually the system will replace the Fed as funder – hopefully before the money multiplier spawns inflation creation.

Up next will be change/temporary elimination of the mark to market rules.

Ready for an enormous spring rally – it is on the doorstep…

Posted by thomsonreutersanalyst | Report as abusive

Take a look at this website – it puts the case for moderate inflation very well.

http://blogsandwikis.bentley.edu/themone yillusion/

Posted by JimP | Report as abusive

Simon, unfortunately no other intelligently occupied world would let any humans onto them cause humans can’t understand what the word ‘greed’ means! it is simple as that. we have let greed be the underlying engine that has run the US and western economies for decades.

I used to told of a thing called ‘a reasonable profit margin’ by my grandfather who was Amish. The way it went was your profit was a fixed item at 9% of the manufacturing costs of an item. Of course one would also have to have either a great or good product or service and give “real” customer service, which DOES not happen anymore. Real customer service died in the late 80’s with the advent of the idiotic automatic voice crap all customers have to endure when we want to have customer service given to us by the companys that we paid out hard earned currency to in the first place.

My ideas to fix the economies are as follows and PLEASE i only have a MBA so i do not consider myself an expert in any fashion about economies.

1. All home mortgages that are in trouble get turned into fixed mortgages and the officers of the banks and holding companies that engineered the ‘Sub-prime market’ take the losses financially, not the American people anymore.

2. House prices are made relevant to what they actually cost to build and their price is partially based on how long the darn thing will survive the elements. Here in the US we pay exorbitant prices for stupid wooden houses, hundreds of thousands of Dollars for each one. These damn things are all made out of the same stuff….. WOOD, a renewable resource. oh wait that is greed again… see what we could do with less greed! now of course the builders and all the industries that make the buying of a new house possible work on the 9% profit thing.

3. All people who work in the legislative industry like congress peeps, senator peeps.. whoever… get NO MORE COLA (cost of living allowance) increases until the median American makes 60% of what they make. These individuals are supposed to be going to state capitals and Washington to represent us, NOT to just get a damn handout from us and then sit around and Piss off.

4. The US stops wanting to fight every damn other country in the world and starts acting like a ‘grown-up’ country and actually leads the world by sitting down and reaching agreements with others by listening to what is causing them pain.. damn wouldn’t that be a great change.. the US listening to someone other than themselves and i also include every time that we tend to listen to what we call out allies. I mean we listen to the complaints of Russia, who happens to sell us 50% of our present oil supply! We also listen to the middle east and not just tow the Israel line. WE encourage Israel to live with their neighbors. If they don’t want to then they are stupid and they deserve what they get. We have for years and years said we want ‘peace in the world’ If that is so then do it and u get peace by listening to complaints and reaching compromise, nor by shaking your “teddy Roosevelt stick’ That stick doesn’t exist anymore.

5. The ‘stock market’ by it’s own definition of itself is it’s a place to ‘speculate’ speculate means u can loose. Therefor I’m very sorry, but all those that lost trillions in the stock market, the market did nothing wrong. It is a speculation market. Oh wait the stock market functions on the idea of Greed!!!! WOW. that word comes up a lot huh?

So if we slow down the greed. things should get better.

6. Now this is really cool. i heard some debating me on this subject that no congress person nor senator person solicited his opinion on how to vote for the banking industry bailout last year nor on anything else. AND yes it is feasible because there is a thing called the internet and our federal legislative representatives have ALL of our email address already. SO major shit and i think that the banking bailout and all the other ones and going to wars should constitute as major things that the internet could be used for soliciting every registered voters opinion. If a registered voter cant make up their damn mind on something, then they cont deserve the right to complain and they better learn the language of government so they can get their constitutional right to being in control of the US government back.

That is after all how the US is supposed to be governed.. ‘by the people’, through their representatives.

I firmly believe if we instituted those six things this world would be much much better.

those are simplistic things that if we have the determination to do them we can do them, but I unfortunately think that there are way more greedy people who would sooner die than let greed go away.

The American dream as it has been spoken of for the past 50 years has died a horrific death. What we seem to have left is just the rich greedy twits who keep telling the majority of citizens that WE owe them all we have.

It should be the other way around. Much more ‘real’ wealth can be generated by insuring that low and middle income citizens have disposable income. THAT is how old ‘real’ wealth was generated and surprisingly it worked. Well, it worked until after world war II ended. Then things changed dramatically. A case-in-point was the, I believe AMC channel original show about a 1950’s era marketing company, where the lead marketing guy was a very greedy crook. But hey it only took 50 years to seriously cripple the US economy through greed.

Maybe it’s no wonder those Catholic dudes all those centuries ago placed good old GREED on the listing of the Seven Deadliest Sins lol

Yes, fixing this mess is going to be very painful and it’s going to take years to fix.

Any serious debate about the listed items is always appreciated.

Posted by mike | Report as abusive

“The US stops wanting to fight every damn other country in the world and starts acting like a ‘grown-up’ country and actually leads the world by sitting down and reaching agreements with others by listening to what is causing them pain.” – mike

In the midst of a once-a-century economic crisis, the $740 billion US defense budget not only did not get cut but got a 3% increase. Under a Democratic president! When this happen, the US has to fight a war every year and fight every damn country in the world. You don’t grow a million pigs without being compelled to slaughter a thousand every so often. Guess what, every country in the world knows it, except the American people.

Posted by TomK | Report as abusive

Re Tomk’s comment with respect to defense spending: I would agree that US defense spending is excessive by any reasonable measure–other than vested interests, political expediency, and living in the warm memories of a cold war past. Examples are innumerable of the tendency to spend on weapons systems rather than boots-on-the-ground type expenditures, the F-35 being a spectacular example. It is a very expensive very mediocre fighter justified for its supposed flexibility and as a ‘node on the net’ when developments are moving rapidly toward less expensive and more capable UAVs. Politically, however, if the current administration were to move against such systems even the likes of McCain would part ways and they’d have the political distraction of being labeled ‘soft on defense’. In any event, the most immediately pressing problems are being addressed first. Let’s cross our fingers and hope that Defense appropriations may be dealt with down the line.

Posted by Atomik Weasel | Report as abusive

Rothschild once said: ” Give me control over a nation’s currency and I care not who makes its laws”. This appears to be the guiding principle behind the actions taken by the Federal Reserve. The current financial crisis was not accidental as some want to portray it. Alan Greenspan, the man in charge of the Federal Reserve, was perfectly aware of what he was doing when he deliberately maintained the interest rates at historically low levels for years. When credit was so easily accessible to the masses, no wonder it produced inflated real estate and stock markets. Of course such generous monetary actions were to the delight of Wall Street who spared no moment in bundling these inflated assets/mortgages into derivatives that were later sold around the world. And the world, in its greed and desire not to miss the hot pie that was selling on Wall Street, didn’t spare a moment in scrutinizing these doubtful instruments. After all who would not be inclined to buy instruments that were carrying resonating names such as “high yield enhanced performance investment vehicles”? It’s in our human nature not to be bothered to check the content when the appearance is so tempting.

The problem is that at this point nobody can put a price tag on these toxic derivatives, it is vehiculated that they are “worth” trillions of dollars. The question is how many trillions? 1? 7?… 100? In which corner of the world are these losses currently located? In this game of greed and manipulation that led to the greatest transfer of wealth in history, who will be the ultimate fool to pay in order to cover this massive black hole? How are these losses spilling into the real economy? How many more million of jobs, homes, pensions, and savings will be lost before we achieve an economic recovery? Because there will be no economic recovery, in US or elsewhere, until the black hole is completely covered. The world is in expectative to see how this is going to be achieved. Is it going to take the form of an US generated hyperinflation that will spill into the other national economies? Or perhaps will take the form of another World War that will reshape the map of the world in a way that serves the interests of the financial/political elite?

What puzzles me is that the Americans are watching the events unfolding under their eyes as if they were watching a reality TV show. No one seems to be decided to take action against the injustice, against the big theft that is being orchestrated against them. It is incredible to watch the inertia of so many bodies and minds alienated and sedated by the decades of genetically engineered food and heavy medication.

Posted by Angelica Treap | Report as abusive

sigh. People still don’t quite get it. The US govt through JP Morgan and Barrick Gold has manipulated the gold price to the downside for years which has the effect of masking the real problems that were there. Gold is the barometer through which risk is gauged against. LIBOR is set primarily off the gold lease rate. If you flood the gold market the rate goes down and real interest rates stay low far longer than otherwise could be obtained. They took away the barometer and now we are where we are. People get wise and buy some gold. This is implied by the article talking about inflation by either deflation of the currency or a combination of that with fed infusions of money. Either way, get some gold or you will be poor at the end of this with nothing left anything.

Posted by jim h | Report as abusive

I cannot understand how the explanation about “one dollar doing the work of 30″ applies to the situation at hand. Maybe that says something about how complex business transactions have become recently – or how incompetent I am. The way I see things, in order to have a subprime mortgage crisis, one needs not only insolvent buyers who take the “subprime” mortgages and lenders who approve and finance the loans, but also sellers who sell the houses (often at overinflated prices) and all sorts of middlemen who get their (often substantial) cut from the deal. I understand how falling prices and customer insolvency create losses on the banks balance sheets, what I don’t understand is how this ended up creating a systemic problem when all the sellers and the middlemen have gotten paid. It seems reasonable to assume that for every subprime mortgage, for every insolvent borrower, a significant amount of liquidity was created on someone else’s balance sheets, somewhere in this economy. Someone had to sell them that overpriced house. If I’m wrong about this, please enlighten me! I understand very well that on the falling side of the asset price curve, capital is destroyed, but on the other hand capital was created on the rising side of the same curve, by the exact same mechanism. The way I see it, the price curve first created capital in the hands of the sellers of real estate, and is destroying it now in the hands of the buyers. The only way this transfer of capital could cause a systemic crisis, it seems to me, is if the capital that was created on the rising leg of the price curve was at least in part withdrawn, not only from the housing market, but from the economy and the financial system as a whole. We can’t all be insolvent, or our debts would cancel each other out. Again, I am open to the possibility that my take on the subject is naive so I would appreciate any comments that would shed light on these issues.

Posted by Andre | Report as abusive

I simply can understand why our ”leaders” are throwing good money after bad. Surely the banking system needs an enema, not more feeding! Wouldn’t the money be better spent rebuilding the manufacturing industries so short-sightedly ”off-shored”. To my way of thinking everybody is going to have to WORK their way out of this situation, unfortunately while being ”lead” by people in the political industry who are welded to people in the finance industry.
What’s the chance of complete and total chaos? Pretty good I’d say, especially after a couple of years of billions being given by the politicians to the banks to no effect, and in the attempt to resuscitate a banking system which has proved it’s totally out of control and is a bottomless sieve.
Where is Blair, the architect of destruction, when his cat rip’s apart it’s bag?

Posted by Peter H | Report as abusive

Mr. Saft, is right on the money!!! We should learn something from emerging markets that constantly have to deal with issues like this. We should just print our way out of this huge problem. We will have to deal with high inflation and a depreciating dollar, but the current alternative of deflation and recession is not going to work, people can not resist this too long. Stay away from fixed income investments!!! inflation is coming!!!

Posted by Fred | Report as abusive

Pick one: An ecomomy that is deflations and is dying slowly. An ecomomy that is inflationary that works a bit better.

Posted by Diogenes XIV | Report as abusive

How will inflation re-float anything? Isn’t it just as likely to send more homeowners underwater? Their mortgage payments may start looking sane again but all the other costs associated with rents and property ownership will rise and at a time when the country is gasping for ways to keep the general population paid highly enough to keep most of the housing stock in this country within reach of most of them. What’s inflation going to do with the already straining social security safety net?

Many people in these pages and previous commentaries have mentioned that the real reason the bubble burst was we aren’t creating enough high paying jobs to support the prices. How many inflated executive positions can an economy support in the long run? And there are no where near enough of them to support a country wide overprices real estate market. It’s almost pathetic that money has to be leant to the wealthy to make them even wealthier simply to stimulate the economy. And they still won’t want to risk it. The federal government expects too much from “noblesse oblige”.

Every country from the time of the Pharaohs through the Roman Empire to the present day has to make jobs. A country that is established and more or less at peace and raising babies all the time has to keep them all busy at something. The whole population can’t be the manager classes or the manager classes can’t do their jobs. WE don’t have enough work for the “workers” you could say. And there aren’t enough “managers” with executive pays to keep all the high cost real estate at the prices easy credit, leverage and speculation were driving them to.

I tend to think the country can’t hide from the billions of much lower paid and more productive people who live in the rest of the world. If they can work and live on so much less so will we have to live on so much less. Water seeks it’s own level.

For those who like historical anecdotes and to serve as an illustration of how lush a society can be and how difficult it is to spur enough real economic activity in a stable society one can look at the Kingdom of the two Sicilies in the 18th century. That rhelm had over 260 days of the year devoted to religious holidays. That meant no one made a living on those days. And few people were really starving. But few people, other than aristocrats, were getting wealthy either. And we are a society with far more automated production than the Neapolitans ever had.

Ionically it was the Catholic Church that complained about the hardship 260 religious holidays imposed on the lower income people. Even the church thought the governemnt overdid the no work on holiday solution to social stability.

Posted by Paul Rosa | Report as abusive

Re: Mr Rosa: I agree with a number of your points. I think, though, that the point with respect to inflation is not that it will ‘solve’ anything. There isn’t any ‘solution’ in that sense that some folks are hoping for–things will, indeed, seek their own level. The question is what method will write down the nonexistant ‘values’ people are still carrying in their heads as to what they think things are ‘worth’ and similarly for the values companies still hold on their books. These values may be written down in one form or another of bankruptcy or the real value of the debts may be written down by inflation making them worth less in real terms. Folks of intelligence and good will may differ over the ideal course, but, of course, events have a way of taking their own path rather than being chosen and no one is really in control. To a considerable extent, just as with the building of the leverage bubble, these are quasi-organic social processes removed from individual decision making–though sometimes some particular individuals may have a critical effect on the course of events.

Posted by Bob, The Atomik Weasel | Report as abusive

Thank you Bob for your polite rebuttal. But if we don’t know the actual cause how will anyone make the correct decision? All this discussion is about finding solutions or all that money that is being pumped into the supine (or is it the sub-prime) victim will be as wasted as giving transfusions to a corpse. That sort of activity is usually the job of the embalmers.

The stimulus money all seems a little like the Maginot Line. Something that worked for the last big crisis but also something that virus in the economic system has already figured out how to immunize itself from. People are so damned sophisticated today.

I’m getting too old to see inflation as any kind of friend. It’s more the kind of solution or result that makes me want to make an appointment with the embalmers myself. I hope I can afford him.

Posted by Paul Rosa | Report as abusive

I think i saw this move at the last Texas holdem tourny. I believe it’s called ” ALL IN “.

The Fed wants to make sure that if we lose this hand, we’re done.


Posted by Truefire | Report as abusive

The Fed and government are going to try to print their way out of this mess and destroy the value of the dollar in the process. When China stops accepting our dollars and debt, people will realize they aren’t worth the paper they are printed on. It is not a questions of _if_ this happens, but _when_ it happens and to what extent.

The only sane place to park your assets and grow your wealth in this environment is gold/silver and precious metals mining companies. I also like ETFs that short the market and short treasuries such as… TBT, SDS and UDN.

Posted by Jason | Report as abusive

I have written Bloomberg, The New York Times, senator Christopher Dodd, and President Obama to attempt to trash this plan for the exact reasons you mention in this article. Giving cheap leverage to the folks who got us into this mess is just another huge taxpayer give away to wall street for which we shall pay the price. The only way I could see the program as being acceptable is to allow the american public access to these same funds to purchase mutual fund shares with the same deal. I’d actually try and exclude wall street, because it’s the american people who deserve to benefit when the improvement happens. Our government is doing everything it can in an attempt to get wall street to lever up once again, and we will end up with exactly the same results. The funny thing is that it’s so clear to so many people except the fed. Unfortunately, such behavior does not lead me to trust the markets and additionally does little to diminish in my mind that there actually exists some sort of agreement between wall street and washington that we don’t know about. I hate to sound like a nut case, but it’s hard to imagine any other reason for this absolute lunacy.

Posted by david b | Report as abusive

Mr. Saft, with all due respect, I think you are obfuscating rather than clarifying this economic crisis. Only meisters of credit-default-swaps and CDO’s could love all the technical mumbo-jumbo in your blog posting. It’s best to keep it simple.

An absolute requirement in this crisis is that all U.S. homeowners, whether they hold a mortgage or not, should be forced to contribute heavily to an economic stabilization plan. The housing bubble was a giant Ponzi scheme which was in the making for about 30 years, and long-time homeowners made out like bandits. Their homes appreciated tremendously, and today most of them face no mortgage troubles at all. Yet, they are still sitting on their big, fat, pretty profits obscenely obtained. Make them pay! Replace all property taxes with a stiff federal property tax, and tax profits on the sale of residential property at a 90 per cent clip. The money generated over 30-50 years would be more than enough to honestly finance an economic recovery plan. Housing prices would tumble even more, but that is EXACTLY what is needed in such jumbo-mortgage states such as California. The U.S. cannot compete on the world-wide economic stage when the price of a necessity like shelter is artificially inflated solely to enrich those who bought shelter first (a Ponzi scheme).

Posted by Darth Baghead | Report as abusive

Andre, the way I see it is this: The crisis
was engineered… I remember thinking about the ever increasing housing market as an oddity simply because most of us not having six figure incomes could not affort their ever increasing value!

I failed to sell and bank my cash under the matress, would I done that I would have been able to buy two deflated properties today.

To those that capitalized (selling high) and now awaite to capitalize further (buying low)
I take off my hat (that’s the nature of the beast) but PLEASE, keep the profit circulating in America!!!

Posted by RenTacus | Report as abusive

Quoting Darth Baghead: “The housing bubble was a giant Ponzi scheme which was in the making for about 30 years, and long-time homeowners made out like bandits. Their homes appreciated tremendously, and today most of them face no mortgage troubles at all”

…. Others than followed wanting to jump on the wagon in fact are the ones now crying fool… thats the nature of the beast, is it not?

Posted by RenTacus | Report as abusive

What a surprise the thompson reuters analyist want to use our money to leverage and reinflate the stock market. Thus paying off hedge funds and private equity which are the same people who got us into this mess by selling toxic assets to the world. they make money selling the junk, and now the government helps them to make money buying it back from all of us who have lost our shirt buying it. Is there something about working in the financial industry that removes all the moral fiber of your being that you’d actually think this is a good idea. Oh wait, the masters who pay your bills will make a fortune. You people are the scum of the earth, and unfortunately our legal system doesn’t allow for what should happen to you, your family, and the families of all the wall street scum who caused this mess in the first place. Since we actually have to work for a living, don’t have enough to invest in the markets, and are just getting by, we don’t care too much about wall street. People like you, out of touch with reality, interested in your own welfare above everyone’s is what got us into this mess. You are advocating a policy that is best for you and your friends, not America as a whole. You make me sick to my stomach!!! Get ready for the big spring rally!!! wow, maybe I’ll put the 200 bucks I’ve got into the market and make a fortune. Clueless!!!! How much money do you make, how much spare money do you have to put in the market? You are going to make a killing from the policy, and I’ll still be stuck attempting to figure out how to make my paycheck stretch to pay the rent. PIG

Posted by db | Report as abusive

A system that depends on debt will not forgive its life’s blood. it would seem that as long as we are stuck in this system, many will pay, few will truly benefit, it is literally designed that way.

The solution is complete change, hampered by battles with words like “socialism” and “debt slavery” being thrown everywhere, a literal quagmire of ideas that is, in my opinion, a perfect smoke screen to keep the train on track.

just shut up and pay, don’t you have to work soon?

Posted by jeremy | Report as abusive

The smoke screen to keep the train on track will burry generations to come, watch and share

http://www.youtube.com/watch?v=lNS8IY_Td 14

Posted by RenTacus | Report as abusive

All what is going on now in the US concerning the Dollar and it’s markets, is now fully manipulated to fail on purpose, they are all just buying time for foreign investors to realize that all US debt-buying is wasted wealth.

Obama & the Fed know it’s all gonna crash, but are trying to position the US into a better position than the rest of the Globe.

The moment Asia stops buying debt, is the moment the US will stop paying it’s debt.

What will happen then is basically a “global economic blackmail” as in ” MAKE US PAY”. The G20 meeting might give us all the general direction of what will unfold.

If your local leaders comes back in a total PANIK, you will know the US as blackmailed the world into a 1 currency system. I think they might just evaluate all currencies to reset the debt values and just Continue this Giant Fiat based counterfeit ring & protection-racket.

Posted by LastReplay | Report as abusive

Great read, espcially liked “So, what’s the implication? Some debt will be repaid but a lot will just be destroyed via default. An organized write-down seems impossible. That will be a huge problem for the banking system and the country, and you can understand why the government does not wish to meet it head on.”

Joseph Stiglitz discussed this recently on Charlie Rose:
http://expattitude.blogspot.com/2009/05/ charlie-rose-joseph-stiglitz-on-future.h tml

Posted by Chloe | Report as abusive