Zeev's Turnips Patch-No Politics (ZEEV)

[Joe Stocks]

Here's an excerpt from Doug Nolands essay this weekend.
http://www.prudentbear.com/creditbubblebulletin.asp

>>> But the issue is not the level of bank capital, but the quality of system debt, distorted asset prices, and a maladjusted economy. Yes, the Fed could have printed money and replaced the banking system’s lost capital in the early Thirties. Yet the $5 billion would have quickly proved irrelevant and impotent in sustaining inflated asset prices, tens of billions of non-productive debt created during the manic stages of the boom, and the insatiable Credit appetite of a maladjusted economy. Yes, a recapitalized banking system could have fed the Bubble awhile longer, but there was no changing the harsh reality that it was a Bubble. No amount of “money” was going to right the system, only extend the wrong.



To return this discussion to the nuance of contemporary finance, when things begin to turn sour, why can’t the Fed simply journal some Fed funds/liquidity over to the likes of Ambac, MBIA, Fannie and Freddie? After all, as long as there is “capital” underpinning the trillions of dollars of securities they have guaranteed, these securities will remain “top rated” and, with Fed assurances, liquid. There will be no liquidity crisis, debt deflation or economic collapse. And, as is the case today, it really doesn’t take much “capital” to support unfathomable amounts of rated debt (as long as confidence holds).



Well, I would argue that the critical issue today is not the imminent losses to be suffered by our behemoth Credit insurers. The issue is, as it would have been had the banks been recapitalized in the early Thirties, that to sustain the boom requires unrelenting Credit creation. As we are witnessing, there is no turning off the Credit insurance engine; there is no possibility of a respite for the GSEs. The day the Credit insurers back away from writing new policies is the day they the are crushed by systemic Credit problems. Yes, the Fed could wire them a few billion, but they have today no alternative than to insure new debt in the tens of billions From Here On Out. The Fed could wire a few billion to Fannie and Freddie, but the issue is that the GSEs will have no alternative than to purchase and guarantee new mortgages to the tune of hundreds of billions annually From Here On Out.



As I wrote last week, the issue is not the little “billions” that the Fed can easily “print” but the Trillions that the U.S. financial sector must create From Here On Out. The Credit system has Bubble binge consumption (with $500 billion current account deficits) to sustain. The Credit system has inflated (in many cases, especially California, grossly inflated) real estate prices to keep levitated. The Credit system has unfathomable quantities of non-productive debt whose value rests on the continued issuance of massive quantities of non-productive debt. The Credit system has a wildly maladjusted monetary/service sector economy - that is an absolute Credit sponge - to maintain.



If, like the early Nineties, we were suffering merely from a credit crunch, Fed “reliquefication” could reinvigorate the Credit system. But today, additional vigor only feeds the out of control financial sphere and further distorts the structure of the real economy. Neither Credit crunch nor deflation is the issue today. The issue is that we have no alternative than to deal with faltering Credit, speculative, and Economic Bubbles of historic proportions. The issue is a massive Credit Bubble that has likely reached the point of being inoperable in reverse. There came a point when Nick Leeson’s losing trade spiraled completely out of control, and the marketplace figured out as much. We think we may be approaching a similar crossroads for the Fed’s trade – “The Great Experiment” - gone terribly awry. And to think the inflationists are giddy to continue betting as if the stakes were only an unlimited number of green chips.<<<