Wednesday, October 08, 2008
Ben Bernanke: "As you know, financial systems in the US and in much of the rest of the world are under extraordinary stress, particularly the money and credit markets." He might have also noted the extreme stress in the stock market.
Not only has the US credit crisis claimed Wall Street's finest, it has spread across the pond to Europe like a raging wildfire, and now threatens the financial viability of a whole country, i.e., Iceland. Iceland is teetering on the precipice of a complete financial meltdown, and is negotiating with Russia to come to the rescue with a loan of 4 billion Euros ($5.4 billion). The country's banking sector dwarfs the island country's whole economy. Iceland has nationalized its 2nd largest bank Landsbanki
and pumped some $680 million into Kaupthing, its largest bank.
The country's 3rd-largest bank, Glitnir, was already nationalized last week. Iceland's financial sector problems have morphed into a currency crisis, as its currency, the krona, plunged 30% against the euro this week.
In the UK, BBC reports that Britain's major banks had asked the UK government to put up billions to bolster their balance sheets, i.e., a direct government bailout, had investors/speculators pouncing on the Royal Bank of Scotland, as investors immediately assumed that any bailout would not be good for stockholders. RBS shares plunged 30%.
In New York, investors, already totally unimpressed by the Congress's passage of TARP 2,
pushed stock prices down further, extending the S&P 500's 2008 YTD losses to 32% and the worst yearly slump since 1937. The DJI is off 29% in 2008, which is also the worst slump in 71 years.
In Japan, the Nikkei 225's forward PER of 12.78X is the lowest in 37 years, with stocks like trading company Marubeni (8002), Mitsui & Co.(8031)and construction equipment maker Komatsu (6301) selling at PERs of just 4.2X, 4.4X and 5.7X forward earnings, respectively. Meanwhile, forward dividend yields are the lowest since January 1975 at 2.39%, with automobile major Nissan (7201)boasting a dividend yield of 7.55%, while Nippon Yusen (9101) and Mitsui & Co. have dividend yields of 4.7% and 4.47%, respectively.
The Obvious Conclusion: The Crisis is Getting Worse, Not Better
With vast swaths of the world's credit and money markets essentially dysfunctional, the crisis, which has already been underway for some 15 months, is getting worse, not better--and global central banks as well as government treasuries beginning with the Fed and the US treasury are no closer to getting their arms around the problem. Indeed, the financial crisis wildfire is basically out of control. In other words, global financial markets are having a A "Minsky moment", where heretofore spiraling debt and incomprehensible amounts of leverage (as in $60 trillion of CDS (credit default swaps) has led to a major selloff and precipitous collapse in market clearing asset prices as well as a sharp drop in market liquidity, i.e., a self-feeding deleveraging paradox or debt liquidation trap.
To central banks, this is essentially a liquidity trap where increasing amounts of monetary stimulation are hoarded by the banks and financial intermediaries to preserve their liquidity (financial viability), with nothing coming out the other end in the form of credit availability to other financial intermediaries or the economy as a whole.
Where is Helicopter Ben?
In 2002, Fed Chairman Ben Bernanke gave a speech in which he pointed out that the government in a fiat money system owns the physical means of creating money. Control of the means of production for money implies that the government can always avoid deflation by simply issuing more money. His referral to a statement made by economist Milton Friedman about using a "helicopter drop" of money into the economy to fight deflation earned him the nickname "Helicopter Ben".
Since banks and other financial intermediaries are no longer functioning as a transfer mechanism of monetary policy, the Fed is "pushing on a string" in using conventional tools to unclog the plumbing of the world's financial system. In other words, the Fed/Treasury must now directly act as the clearing mechanism for financial markets, or bypass the financial intermediaries entirely in giving money directly to consumers or businesses to keep the wheels of commerce turning--i.e., "helicopter money". As we have vividly seen with the initial defeat of TARP, political considerations make it difficult for a monetary/treasury authority to grant a bailout to the financial intermediaries, as consumers and businesses will see no relief until the financial system's plumbing is unclogged.
In its most recent Global Financial Stability Report, the IMF now estimates that financial institution losses from the global credit crisis will now reach $1.405 trillion, which is an upward revision from a previous estimate of $945 billion. The largest losses are expected to be from securitized debt products ($980 billion). In other words, the TARP 2 nominal rescue amount of $700 billion is increasingly looking like Hank Paulson's "water pistol" instead of the intended "bazooka in the pocket". Thus we may have already reached the stage where "helicopter money" may be the only potential solution left to avoid a full-scale debt implosion-induced depression.