This is remarkable. The Toronto star calls this "perhaps the most important story of the year". A group of international banks (including from Canada) have chipped in $200 BILLION in bailout funds for some of the largest US financial institutions just four days after the US Federal Reserve plunked down $245 BILLION (these figures are in US dollars which don't count for much these days) toward a single goal: averting a "crisis in confidence". Confidence...what the entire economic system depends on. If we fail to believe in it, it can't survive.

Despite the Star's claim that this may be the most important story of the year, it was not available on the front page or even on the front of the business section. -ron

Global crisis in world of high finance

Mar 13, 2008 04:30 AM

Toronto Star

Thomas Walkom

The most important story of the week has nothing to do with New York Governor Eliot Spitzer's alleged trysts with prostitutes. Nor does it have to do with Hillary Clinton, Barack Obama and which Canadian government official said what to whom about either.

The most important story of the week – of the year perhaps – is that the international financial system that lubricates and feeds the world economy is in big, big trouble.

So big, in fact, that five of the world's central banks, including Canada's, were forced on Tuesday to take near-unprecedented steps to head off the damage. In effect, the world's top central bankers (which ultimately means the citizens of Switzerland, the European Union, the United States and Canada) have agreed to at least partially bail out some of the biggest financial institutions in the world by briefly taking $245 billion (U.S.) in dodgy loans off their books.

That came just four days after an earlier $200 billion bailout from the U.S. Federal Reserve, that country's central bank. If the move works, commercial lending rates will fall, the stock markets will rise and the central bankers will be heroes. But there is no indication this massive co-ordinated bailout will work. It certainly didn't in December when the five central banks tried a more modest version of the same thing.

Because what is going on in the world of high finance is a global crisis in confidence, something that hasn't happened on a large scale since the 1930s and something that even our sophisticated central banks, such as the Bank of Canada, are no longer well-positioned to solve.

"Crisis in confidence" isn't just one of those mumbo-jumbo phrases. In banking and finance, confidence is crucial for the very simple reason that all involved are kiting – that is to say, lending money they don't actually have.

It's a practice that's perfectly legal. And it usually works – unless all those owed money (and that includes people with modest savings accounts) want all of it back at the same time. Think of those photos from the Depression of farmers lining up around the block to remove their savings from failing banks.

Paul Krugman, an American economist who also writes in The New York Times, calls the current international credit crunch a less visible version of a classic run on the bank, which is probably a good way to look at it. Thanks to the plethora of peculiar and incomprehensible loans that have been allowed to develop and which are now in trouble (of which so-called sub-prime mortgages are only one example), big lenders have become exceedingly wary of extending credit to one another.

So far, that unease has expressed itself largely through commercial or mortgage interest rates that are stubbornly refusing to come down as quickly as the central banks wish. But the real fear is that big institutions holding some of the dodgiest assets may face bankruptcy, causing them to suddenly call in all the loans they have out.

Which, as the effects ricochet through the system, would lead to massive layoffs in even the soundest of firms.

Incidentally, these kinds of confidence problems, while certainly connected to the current slowdown in the U.S. economy, have implications far beyond those of a normal recession. On top of everything else, they are harder to fix.

Canadians have experienced wrenching economic downturns in recent times. But we haven't seen a full-blown international financial crisis for almost 70 years. They are not fun.

Thomas Walkom's column appears Thursday and Saturday.

By Barry Grey | 13 March 2008 | WSWS

In the face of a mounting panic on US financial markets, the
Federal Reserve Board on Tuesday announced it would lend major
Wall Street investment banks up to $200 billion in Treasury bonds
and accept as collateral mortgage-backed securities for which
there are currently no buyers on the market.

The so-called “term securities lending facility”
announced by the US central bank was coordinated with four other
central banks—the European Central Bank, the Bank of England,
the Bank of Canada and the Swiss National Bank.

Under the plan, the Fed will loan up to $200 billion of its
more than $700 billion hoard of Treasury bonds for a period of
28 days, in effect vouching for the credit-worthiness of mortgage-backed
assets that have plummeted in market value along with the collapse
in US home sales and prices, and which otherwise would have to
be written off as losses by the finance houses.

By accepting privately originated mortgage-backed securities—in
the past the Fed had accepted only securities issued by the government-sponsored
mortgage lenders Fannie Mae and Freddie Mac—the US central
bank agreed to take as collateral some $1 trillion in securities
that previously would not have qualified.

In announcing the massive debt relief plan for Wall Street,
the Fed said it was prepared to take further action if market
conditions warranted, suggesting it would be willing to roll over
the loans for additional 28-day periods.

Tuesday’s Fed action followed its announcement the previous
Friday that it would expand its short-term loan program for the
big commercial banks, the so-called “term auction facility”
initially launched last December, from $60 billion to $200 billion.

Since August, when the collapse in the housing market led to
a credit crunch, the US government has provided nearly $1 trillion
in direct and indirect backing to financial firms in an attempt
to unfreeze credit markets. At the same time, the Fed has slashed
short-term interest rates five times, bringing them down from
5.25 percent to 3 percent. It is believed all but certain that
the Fed will announce a further reduction in its federal funds
rate of at least 0.5 percent when its policy-making committee
meets again on March 18.

None of this, however, has resolved the massive crisis caused
by the collapse of a housing bubble and credit bubble that were
inflated in large part on the basis of sub-prime mortgage loans
sold to home-buyers who lacked the financial means to sustain
their mortgage payments.

Bankers, mortgage company executives, and speculators raked
in huge profits and compensation packages on the basis of a vast
pool of cheap credit backed by little more than the expectation
that home prices would continue to rise forever. The resulting
crash threatens a social catastrophe—with record home foreclosures
and growing unemployment—and a financial breakdown of historical
proportions.

The Fed’s action on Tuesday sparked a frenzied rally on
US stock exchanges. Wall Street snapped a three-session losing
streak—prompted in part by last week’s Labor Department
report showing a net loss of 63,000 jobs in February—and
share prices soared, led by financial sector stocks. The Dow Jones
Industrial Average rose 416 points, its biggest one-day rise in
five years.

However, credit markets remained more subdued, and the price
of many forms of debt continued to fall, reflecting underlying
anxiety about the solvency of major banks and financial institutions.

The Fed took its extraordinary action Tuesday in the hope that
by temporarily relieving investment banks and brokerage firms
of mortgage-backed assets that are losing value and depleting
the firms’ capital, and placing the prestige of the Fed behind
the tarnished securities, the Wall Street finance houses will
be spurred to loosen their credit requirements and lend money
more freely to other banks, companies and individuals.

However, Steven Romick, a partner at First Pacific Advisors
in Los Angeles, told the Los Angeles Times, “It’s
only a stay of execution. It gives them some time to work through
their problems, but it doesn’t solve their problems. We believe
this euphoria is temporary.”

Press accounts provide some indication of the panic conditions
that prompted the Fed’s move on Tuesday. Steven Pearlstein,
the financial columnist for the Washington Post, wrote
on Wednesday:

“But the real problem began in late February, as several
of Wall Street’s biggest investment banks prepared to close
their books for the quarter and realized they were looking not
only at big declines in profit from issuance of new stocks and
bonds and fees from mergers and acquisitions, but also at another
round of write-offs in the value of their holdings. In response,
the banks began to hunker down, instructing their trading desks
to raise margin requirements for hedge funds and other customers,
requiring them, in effect, to post more collateral on their heavy
borrowings.

“Thus began a chain reaction in which hedge funds began
selling what they could—largely mortgage-backed securities
guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae—to raise
cash to meet their new margin calls. That wave of forced selling
drove down the price of those bonds, which prompted more margin
calls and more forced selling. By the end of last week, the interest
rate spread on those securities—the difference between their
yield and that of risk-free US Treasury bonds—had jumped
four, five, even ten times the normal rate.

“Among those caught up in the vicious cycle were hedge
funds run by such blue-chip names as KKR and Carlyle Group, along
with Thornburg Mortgage, a big mortgage lender. News of their
troubles swept through Wall Street, heightening the sense of panic,
as did rumors that Goldman Sachs was about to post big losses
and Bear Stearns was about to run out of cash. Meanwhile, Lehman
Brothers announced that it would lay off 5 percent of its staff
in what was viewed by many as a first installment of a consolidation
that would eventually eliminate 20 percent of the jobs on Wall
Street. Analysts began to warn that financial-sector losses from
mortgages, commercial real estate, failed takeover loans and other
bad bets would reach as high as $1 trillion.”

The New York Times described the situation as follows:
“The main point of the effort on Tuesday was to prevent or
at least slow down a chain reaction of forced selling on Wall
Street. In recent days, market prices for seemingly safe debt
had fallen so much that major financial institutions were being
forced to put up more capital to secure their debt.”

The Wall Street Journal provided an account Wednesday
of the crisis atmosphere that attended the emergency consultations
which led to the $200 billion initiative. “The Fed began
considering its latest steps last week,” the Journal wrote,
“as credit jitters intensified. Fed officials finalized details
on their plan on Sunday with foreign counterparts attending a
meeting of the Bank for International Settlements, the Switzerland-based
central bank for central bankers. The Fed’s policy-making
Federal Open Market Committee met by videoconference for an hour
and a half Monday night to approve the measures.”

As these reports make clear, the Fed, far from pursuing a long-term,
well considered strategic plan, is scrambling, along with its
central bank counterparts internationally, to keep abreast of
a rapidly widening and worsening economic crisis and contrive
stop-gap measures to avert an immediate crash.

At the same time, the flood of liquidity being pumped into
the credit markets is fueling inflation and further undermining
the US dollar, creating the conditions for an even deeper and
more protracted crisis. One sign of this process is the accelerating
rise in crude oil prices. On Tuesday, crude oil futures soared
above $109 a barrel, setting a new record.