Two “voices” weigh in on recession possibility

First, former Clinton Treasury Secretary Larry Summers. And, since Summers is now part of a hedge-fund group, he ought to know, right?

But, like a number of Congressional Democrats, he wants the easy way out of letting Fannie Mae and Freddie Mac carry a larger loan portfolio.

To be, this is just one or two steps removed from a full-blown bailout. Bush is probably right that the two agencies need to be reformed first. But, of course, the Fed needs to be reformed even more.

And, the second voice, speaking of reforming? The Fed First, former Clinton Treasury Secretary bent its own rules last week for Citigroup and Bank of America:

The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup's Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letters, to provide liquidity to those holding mortgage loans, mortgage-backed securities, and other securities.

And, this isn’t a minor issue:

So, how serious is this rule-bending? Very. One of the central tenets of banking regulation is that banks with federally insured deposits should never be over-exposed to brokerage subsidiaries; indeed, for decades financial institutions were legally required to keep the two units completely separate. This move by the Fed eats away at the principle.

Sure, the temporary nature of the move makes it look slightly less serious, but the Fed didn't give a date in the letter for when this exemption will end. In addition, the sheer size of the potential lending capacity at Citigroup and Bank of America — $25 billion each — is a cause for unease. ….

Don't forget: The Federal Reserve is in crisis management at the moment. However, it doesn't want to show any signs of panic. That means no rushed cuts in interest rates. It also means that it wants banks to quickly take the big charges that will inevitably come from holding toxic debt securities. And it will do all it can behind the scenes to work with the banks to help them get through this upheaval. But waiving one of the most important banking regulations can only add nervousness to the market. And that's what the Fed did Monday in these disturbing letters to the nation's two largest banks.

I’m not enough of a financial analyst to tell you where to invest, but I can safely say that if you have any money in stocks, make sure it isn’t in bank stocks.

Financial-industry blogger Mish has more.

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Couldn’t have said it better about financiers in the credit bubble myself

So, I’ll let Bill Fleckenstein say it for me:

One final comment about the financial world: It's populated with rich, hypocritical whiners. Wall Street, the hedge-fund community and their lap dogs in the news media continually brag about how much they love capitalism and free markets.

Yet when the creative-destruction component of capitalism rears its ugly head, they want the central planners to bail them out immediately, before they take any pain. And the ones clamoring the loudest are the very same folks who behaved the most irresponsibly.

Fleckenstein goes on to note that the Financial Standards Accounting Board has allowed much of this bubble to happen right along with the Fed, through it’s officially signing off on counting Level 3 values, based on fair value being measured using “unobservable inputs,” as part of a company’s assets.

See this Bloomberg article for how far Wells Fargo is running with this ball.

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Financial services passes 100,000 mark

That is to say, that's the number of jobs lost this year.

Mish adds that we should be on the lookout for a domino effect; many of these people have little savings cushion and will themselves have houses go into foreclosure.

Mish also warns that, so far, we’re just talking about residential real estate:

Far from being the savior that many think, commercial real estate is soon going to get crushed. It is overbuilt, overloved, and due for a collapse. If Bernanke thinks he has a problem now, watch what happens when commercial real estate blows up. Fannie Mae (FNM) and Freddie Mac (FRE) might be able to keep people in their houses in lieu of foreclosure by renegotiating terms down and down again (for a while anyway but certainly not forever), but bank funding of unneeded strip malls is another thing indeed.

In other words. Democratic presidential candidates, as well as Fed chief Ben Bernanke, need to have serious answers to tough economic questions.

Meanwhile, the “Implode-O-Meter” says 137 major lenders have imploded since last year.

And, rising rates on jumbo mortgages (houses above $417,000) threaten what is theoretically the most healthy part of the housing economy.

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Top Swiss banker agog at U.S. lending standards

Credit bubble looks more and more globalized

Roth says story is just beginning:

“We’re certainly not at the end of the story. There are question marks surrounding the development of the American economy,” Jean-Pierre Roth, president of the Swiss National Bank, said. “Something unbelievable happened. People who had neither income nor capital got credit with very attractive conditions. Now reality is striking back,” he said.

Meanwhile, a financial analyst says not all of the collateralized debt obligations have been priced to market, so we still don’t know exactly how serious things are.

Stock market historian David Schwartz warned investors not be fooled by signs of recovery. “The truth is no-one knows how serious the financial problem in the US is, nor how it will unfold. We do know central banks are scared out of their minds,” he said.

The credit bubble Roth says is global became global because foreign banks either followed the Fed’s lead or inflated their countries’ credit for their own reasons, as with Japan.

In parallel, the Bank of Japan held interest rates at zero for six years until July 2006 to stave off deflation. Even now, rates are still just 0.5pc. It also injected some $12bn liquidity every month by printing money to buy bonds. The net effect has been a massive leakage of money into the global economy. …

Faced with an asset shock coming from Asia, the Federal Reserve and the European Central Bank could have taken counter-action. They did not do so. Nor did they tighten much to offset liquidity being "created" by the new-fangled credit instruments. The Fed held rates at 1pc until June 2004, when the economy was growing at 5pc. The ECB kept rates at 2pc until December 2005. It takes 18 months - or so - for monetary policy to exert its full effects. The bubble peaked in early 2007.

The central banks have said their task is to fight inflation, not to police asset prices. Critics retort that the US asset bubble in the 1920s and Japan's bubble in the 1980s both occurred at a time of low inflation. Belatedly the Bank of Japan, the ECB, the Swiss, the Scandies and the Bank of England are questioning the wisdom of ignoring asset prices, deeming it wise to "lean into the wind" to slow excesses. But it is very late in the day. The credit bubble is already with us.

And, that’s why this thing isn’t going to go away overnight.

Also, related to that, if Bernanke seriously cuts the Fed funds rate, other countries’ central banks will look to their own houses. Just like warring tariff hikes exacerbated the Depression, warring rate manipulation may do the same for the credit bubble.

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