Busted: Bankers and The Global Economy

February 14, 2008

Bernanke Admits Banking Stress to U.S. Senate

elvis1.gifBen Bernanke admitted details of the state of U.S. banking and finance today. Bernanke admitted the considerable strain of financial markets since last summer. He cited “heightened investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates” which triggered the financial turmoil. The reality is that record default on these subprime variable-rate mortgages is what began the turmoil. Once the money strain showed on their bond investments, the investors affected became concerned. Bernanke also pointed out the relunctance of investors to bear risk and difficulties in valuing complex or illiquid financial products. Bernanke is referring to the lack of willingness to get involved in the banking debt issues of other banks and notably referring to the internal banking climate as well as the highly controversial and complex internal banking products that threaten the liquidity of the entire banking and financial market. The uncertainly of these instruments coupled with the losses of major financial institutions in the current banking crisis and the continued weakness of the economy has put the commercial banks and financial institutions under the gun.

As the concerns of investors increased, money center banks and other large financial institutions have come under significant pressure to take onto their own balance sheets the assets of some of the off-balance-sheet investment vehicles that they had sponsored.” This statement also refers the internal banking instruments that banks tied to their subprime bonds and other internal profiteering measures. These instruments bear liquidity and interest issues as capital dries up. Banks could be faced with writing off failing financial instruments, further lowering the asset value of the banks and creating further liquidity problems for the industry. “Bank balance sheets have swollen further as a consequence of the sharp reduction in investor willingness to buy securitized credits, which has forced banks to retain a substantially higher share of previously committed and new loans in their own portfolios.” This bankspeak indicates that banks are refusing to buy loans from other banks and resell them, a typical method banks use to free up money to create more loans and debt through their customers. This creates a crunch because the loans must remain on their portfolio since they cannot sell them off or move them from their ledger.

The fact that banks cannot move loans strongly affects profitability and slows down growth. All these factors can create a terminal financial condition for underfunded and undersecured banks. The big boon of the fractional reserve becomes the “Achilles heel” as asset values drop and profitability is curtailed. “Banks have also reported large losses, reflecting marked declines in the market prices of mortgages and other assets that they hold. Deterioration in the financial condition of some bond insurers has led some commercial and investment banks to take further markdowns and has added to strains in the financial markets.” Markdown is a function of interest rates on bonds, which strains profits in an already strained market as bonds are devalued.

Bernanke is taking a middle-of-the-road approach to policy and finance to play it safe for the remainder of 2008. Bernanke is hopeful. “My baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal stimulus begin to be felt.” He vowed that the Fed will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.

The banking and financial community is in a huge pressure cooker right now. The largest wild card in the banking crisis is the internal banking instruments that bankers invented to remove debt from banking ledgers in an effort to create profits and increase asset numbers. How well this pressure is managed will have more to do with the depth of the banking crisis than most other factors over the long-term. Bankers know that combining the subprime mortgage issue with internal banking instruments is capable of putting some banks out of business. While a brave face is important, many bankers are shivering with concern from a crisis of their own making.

Elvis Manning

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1 Comment

  1. Good day, Your blog inspires me. Life Lock

    Comment by Life Lock — February 15, 2008 @ 12:15 am


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