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General Motors used to be among the giant companies widely considered “too big to fail.”
Almost all of Wall Street said a GM bankruptcy was “unthinkable.” Most Americans didn’t even consider it as a real possibility. And as recently as February, outgoing and incoming administration officials were still insisting they would never let it happen.
But three and a half years ago, in our October 11, 2005 edition, “GM Headed for Bankruptcy,” I warned you that “too big to fail” was a myth … that the myth would be shattered … and that the final day of reckoning for General Motors would be in federal bankruptcy court.
Now, that day is here.
General Motors, once the world’s largest company, will be in a New York bankruptcy court, filing for Chapter 11 later today, and it’s high time to declare that …
“Too Big to Fail” Has Failed
Plus, it’s high time for all Americans to confront a new, more sober reality: The government is not nearly as powerful as advertised.
Case in point: If you’re among those who thought Fed Chairman Ben Bernanke had the power to end this debt crisis, think again.
Despite the most massive bond buying spree in the Fed’s 95-year history, Bernanke has failed to stem an avalanche of selling by bond investors … failed to stop bond prices from plunging … and failed to roll back a rising tide of long-term interest rates.
How is this possible?
For a quick review of the events, just rewind the clock to the Fed’s March 18 press release, when Bernanke launched his newest, high wire act with great fanfare and bravado.
At that time, despite $700 billion on TARP funds authorized by Congress, the U.S. Treasury Department was making virtually no headway in unfreezing credit markets. The world’s largest lenders were still in gridlock. Most forms of credit were still unavailable to even the most worthy borrowers. The credit-addicted global economy, suddenly deprived of its regular debt fix, was in convulsions, collapsing uncontrollably.
So, in a desperate attempt to jump-start the credit markets, Bernanke dared go where no other Fed Chairman had gone before.
He dropped short-term rates to zero.
He committed to buying $300 billion in long term Treasury securities plus another $100 billion in government agency securities.
He even promised to buy up to another $750 billion of mortgage-backed securities.
Total new commitments in that one announcement alone: $1.15 trillion.
But by going so far out on a limb so fast, it was impossible for the Fed Chairman to estimate what the impact might be. There was no historical precedent. No way of knowing.
He didn’t know how worldwide bond investors might respond.
He couldn’t begin to guess to what degree his actions might rekindle their inflation fears or damage their trust in the credit of the U.S. government.
He had no basis for estimating how many investors would shun or dump U.S. bonds … how far they could drive down bond prices … or how far they might push up long-term interest rates.
Worst of all, if, for whatever reason, his new venture truly upset the equilibrium between the supply and demand for bonds, he had no Plan B.
In a nutshell, on March 18, Ben Bernanke jettisoned his balancing poles, abandoned any policy safety net and launched a stunt that would make the most daring tightrope walker tremble with fear.
And unfortunately, right now, even before all the moneys have been spent, the enterprise is already beginning to fail.
The critical events …
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Event #1
Huge Fed Purchases of Treasuries
Since March 25, the Fed has been buying Treasury notes and bonds like they were going out of style.
The Fed kicked off the program with a purchase of $8 billion and followed up with another $7.5 billion two days later. Since then, the Fed has jumped into the Treasury-bond market with average purchases exceeding $5 billion at least 10 times per month.
Total bought so far: $130.5 billion.
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Event #2
Despite the Fed’s Giant Purchases,
Treasury Bond Prices Have
Continued to Plunge
Instead of rising or stabilizing as Bernanke had hoped, Treasury bond prices have fallen sharply.
Sure, bond prices momentarily jumped higher in the wake of the Fed’s landmark March 18 announcement. And yes, they have typically enjoyed mini rallies whenever the Fed bid up the market with some more big bucks. But in the final analysis, bond prices have wound up sharply lower and long-term rates sharply higher.
Event #3
Mammoth Fed Purchases of Mortgage Bonds
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The amounts the Fed has poured into the market for mortgage-backed securities (MBSs) make its Treasury purchases look small by comparison: The Fed launched the program with a $10 billion purchase on January 7, ramping it up quickly from there, and buying up to $33 billion a pop by late March.
Total bought so far: A whopping $507 billion!
Event #4
Despite the Fed’s Mammoth Mortgage
Bond Purchases, We’ve Just Seen a
Sudden Collapse in Mortgage Bond Prices
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For a while, it seemed the Fed was able to hold the line, keeping the price on a benchmark long-term mortgage bond near the 100 level.
But last week, the market collapsed. And even with a modest recovery on Friday, there is no mistaking the abject failure of the Fed to keep mortgage prices up and mortgage rates down.
This all raises the simple but unanswerable question:
Now what?
Since the Fed has no Plan B, what does it do next?
Does it print more money, buy more bonds and pray that despite no change in policy, it will magically see a change in results?
Does it try to repeal the law of gravity — to somehow prevent sellers from selling and falling prices from falling?
Does it seek to travel back in time — to somehow reverse the blunders of past Fed Chairmen who helped create today’s debt monster in the first place?
Sorry, but those “solutions” are both insane and impossible.
Why? Why are they insane and why is Bernanke’s policy a failure?
Because his tight wire is flanked by two, conflicting — and destabilizing — forces, only one of which can possibly be countered at any one time.
Destabilizing Force #1
Too Much NEW Debt
The Treasury alone will need to issue a whopping $1.84 trillion in net new Treasury securities this year — just to finance the deficit expected by the Obama Administration.
That excludes any larger deficit due to a worse-than-expected decline in the economy.
It excludes any costs for credit that goes bad (among the trillions that the government now guarantees).
It even excludes the $50 billion additional funding now being contemplated for General Motors … or the hundreds of billions now being demanded by cities and states … or the uncountable billions from any future shoe to fall.
Yes, a lot of people seem to think the Fed can just print all the money it needs and inflate away the problem. But these people have conveniently ignored …
Destabilizing Force #2
Too Much OLD Debt
According to the Fed’s Flow of Funds Report (pdf page 67, Table L.4), at the end of last year, there were $14.5 trillion in Treasury securities, agency securities and mortgage-backed securities outstanding in the world — precisely the ones the Fed has been trying to buy up this year.
The big dilemma: If just 10 percent of those are dumped on the market, it would trigger the sale of $1.45 trillion worth, easily overwhelming the Fed’s purchases.
The bigger dilemma: The main reasons investors sell — fear of inflation and damage to the U.S. government’s credit — are, themselves caused by the Fed’s own buying. In other words, the more the Fed buys, the more our bond investors are motivated to sell.
Bottom line:
- To the degree the Fed rushes into the market to deal with destabilizing force #1 — too much new debt — it merely aggravates destabilizing force #2 — too much old debt. And …
- Ultimately, there’s only one way the Fed can resolve force #2 and convince investors to hold on. It must abandon its efforts to counter force #1. It cuts back or stops its money printing to buy up bonds.
Just a future scenario? Not quite.
My charts above demonstrate that this is already beginning to happen right now: Mr. Bernanke’s daredevil tight wire act is already a failure.
The great day of reckoning of this massive government rescue enterprise is already approaching.
My Recommendations
Do not be deceived by the Fed’s supposedly almighty powers.
Do not get lured in by Wall Street’s hype.
And whenever anyone tells you that a company is “too big to fail,” just remember General Motors.
Good luck and God bless!
Martin
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