The Credit Collapse–The World’s Bankers Revert to Saying “No”

A recent news article titled Dresdner Rescues $19 Billion SIV, Follows Citigroup illustrates the severity of the global liquidity collapse. Note that the article mentions that the K2 SIV had no “direct exposure” to securities backed by subprime or midprime debt. But yet the fund failed dramatically. This adds credence to my assertion that the world’s entire credit market is essentially broken, and that despite frantic attempts by the central banks to inject liquidity (BTW, another $25 billion was just injected the Fed on Thursday), most of the major financial institutions are starting to crumble.

In the very near future, we will be reading headlines trumpeting the collapse of multi-trillion dollar derivatives schemes and dozens of hedge funds. In essence, no financial institution will be immune. It won’t stop with the exotic “alphabet soup” CDO, CDS, MBS, and SIV investments. The problem is systemic. By endlessly repackaging and re-selling debt instruments, the bankers have built themselves a multi-hundred trillion dollar house of cards. The labyrinth of debt repackaging made it impossible for anyone to gauge risk. Nobody knows what exactly what collateral is backing up any given debt-based investment vehicle. Worse yet, while currencies are inflating, assets–such as houses–are deflating. Thus, even the once “solid” backing of residential house mortgages is nothing but sinking sand. Without a quantifiable measure of risk, it is impossible to judge whether any business venture is creditworthy. Hence, the bankers have defaulted to the time-honored answer that they have given to any potential borrower that cannot prove the value of his assets: NO! (As in: “No, we are not giving you the loan that you applied for.”) Global finance has already dramatically slowed. Without liquidity, the wheels of commerce are grinding to a halt. It is particularly noteworthy that the number of new derivatives contracts being written has dropped by more than 90% since August. (And many of those still holding derivatives are biting their nails.)

The global credit collapse will eventually lead to some huge bank and S&L runs and equally huge municipal bond failures. These, in turn, will spawn massive Federal bailout schemes that will make the Chrysler bailout of 1979 and the S&L bailout in 1989 seem miniscule by comparison. Since there will not be nearly enough tax dollars to fund these bailouts, the government will resort to creating new Treasury debt. Tax incentives, large scale civic works projects, and other desperation measures to “jumpstart” the economy will result in even more debt. But since there will be few takers for this mountain of new debt, the Federal Reserve will be forced monetize most of the debt–in effect creating trillions of new dollars out of thin air. This monetization will be insanely inflationary. (On the scale of what I described in my novel “Patriots: Surviving the Coming Collapse”.) I am talking inflation in the Zimbabwean sense of the word. The name Ben Bernanke may someday be remembered in the same breath with the name Robert Mugabe.

The Asian financial crisis of 1997 very nearly started this avalanche, but that problem was contained and fairly neatly varnished over by the mass media. But this new crisis–which started with shaky loans to flaky home buyers in the United States–cannot be stopped until it reaches its inevitable conclusion. So, instead of Thai Baht currency speculators, it will be lower middle class Americans that bought houses with granite countertops that will be remembered as the culprits. “It was the Americans that started this depression”, they will all say. And the symbol of this villainy will undoubtedly be the Dollar Sign ($). Don’t expect the US dollar to survive this crisis. At the very least it will lose its status as a the world’s reserve currency, but more likely it will suffer mass inflation and find its place the dustbin of history. All unredeemable fiat currencies eventually meet their doom. Some are just quicker about it than others.

The current financial instability is just the beginning. Before this is over, the debt crisis will start an avalanche that will bankrupt countless individual investors, institutional stockholders, hedge funds, stock trading companies, municipalities, banks, S&Ls, and insurance companies. Since the magic money tap will be turned off, both residential and commercial real estate may decline–absent overall consumer inflation–by as much as 70%. Stock markets will collapse, and economies will be plunged into prolonged depression. On and on it will go, as the trillions of dollars worth of bad debts that have been winding up for the past two decades are gradually “unwound.” This unwinding will be an incredibly painful and protracted process that is punctuated by some massive layoffs, strikes, and social unrest. Dan Ackroyd said it best: “Real wrath-of-God type stuff.”

I suspect that the debt avalanche will destroy entire currencies and possibly bring down governments. (We should remember that the Asian financial crisis of 1997 led to the ouster of the 30+ year Suharto regime in Indonesia.) My only hope is that one of the institutions that is replaced is the private banking cartel called the Federal Reserve. Inevitably, we need to replace fractional reserve banking with proper warehouse banking, and replace the fiat currencies with ones that are freely redeemable for precious metals.