[NYTr] Near-panic atmosphere as US Fed Reserve Chair Testifies before Congress

[All the News That Doesn't Fit]

sent by tsimonds 

World Socialist Web Site - Nov 9, 2007
http://www.wsws.org/articles/2007/nov2007/bern-n09.shtml

"The US economy, saddled with massive trade and current account
deficits, depends on daily inflows of billions of dollars in capital
from China, Japan and other countries for the functioning of its
financial system. Any significant contraction of these capital flows
would lead to a collapse in the dollar, massive interest rate
increases, deep recession and the possibility of a US and global
depression."


Near-panic atmosphere as US Federal Reserve chairman 
testifies before Congress

By Barry Grey

On Thursday, one day after American stock markets plummeted in the face
of mounting bank losses, soaring oil prices and record lows for the US
dollar, Federal Reserve Board Chairman Ben Bernanke gave a gloomy
economic forecast in testimony before Congress Joint Economic Committee.

Bernanke admitted that the US housing slump and the credit crisis
resulting from soaring defaults of subprime mortages had worsened since
credit markets froze last August, and predicted that US economic growth
would fall sharply in the fourth quarter of 2007 and the beginning of
2008.

He said the housing crisis would worsen in the coming months, as
millions of homeowners with adjustable rate mortgages faced sharply
higher interest payments when new rates kicked in, and hinted that the
crisis on Wall Street could spiral into a full-blown recession.

On Wednesday, the Dow Jones Industrial Index fell 360.92 points, wiping
out all the gains since the Feds half-point interest rate cut on
September 18. The Standard & Poors 500 index dropped by 44.65, while the
Nasdaq Composite Index shed 76.42 points. The rout on Wall Street was
precipitated by a series of developments underscoring the depths of the
financial crisis.

As the dollar hit record lows against the euro and other currencies,
Chinese officials said the weakness of the US dollar could lead them to
diversify their $1.43 trillion in foreign exchange reserves into
stronger currencies, such as the euro. A Chinese central bank vice
director told a conference that the dollar was losing its status as the
world currency.

The US economy, saddled with massive trade and current account deficits,
depends on daily inflows of billions of dollars in capital from China,
Japan and other countries for the functioning of its financial system.
Any significant contraction of these capital flows would lead to a
collapse in the dollar, massive interest rate increases, deep recession
and the possibility of a US and global depression.

Also on Wednesday, French President Nicolas Sarkozy, in an address to
the US Congress, criticized Wall Street excesses and the weak dollar and
warned that monetary disorder risked turning into economic war. Sarkozy
was speaking for a European bourgeoisie that is increasingly angered by
a US monetary policy that has cheapened the price of US exports, made
European imports more expensive, and begun to seriously impact European
business.

The same day, oil futures, up more than 65 percent in the past year,
topped $98 a barrel for the first time. Gasoline prices in the USalready
significantly higher than last monthare now expected to follow the surge
in oil, and Americans winter heating bills are expected to rise even
more sharply than initially feared.

The meltdown of so-called collateralized debt obligations (CDOs) and
other subprime-linked securities continued with the announcement by
Wall Street investment bank Morgan Stanley that it was writing off $3.7
billion for the fourth quarter, and that its losses could rise to $6
billion. It joined such other giants as Citigroup, Merrill Lynch and
Goldman Sachs which have announced multi-billion-dollar write-downs in
high-risk, high-yield investments in the housing market and other forms
of financial speculation.

So far this year there have been an estimated $55 billion in losses
suffered by financial institutions, but this is just the tip of the
iceberg. The chief credit strategist at the Royal Bank of Scotland Group
issued a report Wednesday estimating that the credit crunch will cause
$250 billion to $500 billion in losses at banks and brokerage houses
around the world. The upper range of his estimate is equal to the
combined stock market value of the three largest US banks, Citigroup,
JP Morgan Chase and Bank of America.

Adding to the mood of fear and crisis on Wall Street was the
announcement by the American International Group, the worlds largest
insurance company, that it had written down nearly $2 billion in
investments related to mortgages in the third quarter and expected to
write down an additional $550 million in the next quarter, and a
warning from the savings and loan firm Washington Mutual that it faced
massive credit losses. Washington Mutual stock fell more than 17
percent for the day.

Finanlly, General Motors took a $39 billion charge to its third-quarter
results to offset the value of deferred tax assets.

The crisis atmosphere surrounding Bernankes appearance before Congress
was further stoked by weaker-than-expected data on US retail sales
released Thursday morning. The data, showing sluggish sales by such
retail giants as Wal-Mart, Macys and Kohls, suggested that US consumer
spending, which accounts for 70 percent of the economy, was falling off
as a result of declining home values, rising foreclosures, soaring
gasoline and heating costs, and pervasive economic insecurity. The
reports made for a bleak prognosis for the holiday season, upon which
retailers and the US economy as whole are hugely dependent.

The mood for Bernankes appearance before Congress was set by the opening
statement from New York Senator Charles Schumer, the chairman of the
Joint Economic Committee. The Democratic senator, known as a reliable
mouthpiece for Wall Street interests, began by noting that since
Bernankes previous appearance before the committee in March, contrary
to what you said at the time, the subprime mess has not been contained,
but instead has proved to be a contagion that has spread in dangerous
ways throughout not just the housing market, but our economy and the
global financial system.

Schumer said that in the aftermath of the seizing up of the credit
markets in the summer, there is now a lack of confidence in
credit-worthiness throughout the market.

He continued: However, while we did weather that summer storm, Im very
concerned that there may be a bigger storm on the horizon. Quite
frankly, I think we are at a moment of economic crisis stemming from
four key areas: falling housing prices, lack of confidence in
credit-worthiness, the weak dollar and high oil prices. Each of these
problems alone would be enough of a threat to our economic well-being.
But taken together, they are essentially the four horsemen of economic
crisis...

Even our bedrock assumptions are being put into doubt. As housing prices
decline, there are real fears that we wont be able to depend on
consumers, the engine of our economy over the past few years, to keep
spending. And now we hear that foreign investors may no longer be
confident in the dollar as the global currency of choice. Im not
surprised to hear experts, such as your predecessor Alan Greenspan, warn
about the threat of recession. Ive begun to worry about worse.

In particular, as I watch bank after bank write down bad investments
tied to baroque financial instruments that even sophisticated investors
dont understand, I fear for the stability of our financial system.

Bernanke provided little solace. While noting that the US gross domestic
product rose at a strong 3.9 percent rate in the third quarter, he
warned that such a rate could not be sustained because of the ongoing
correction in the housing market, and added that inflation was bound to
rise because of recent increases in energy prices.

He admitted that financial markets remained under significant pressure,
saying the financial turmoil was triggered by investor concerns about
the credit quality of mortgages, especially subprime mortgages with
adjustable rates. He spoke of the continuing increase in the rate of
serious delinquencies for such mortgages, and warned that they were
likely to rise further as a sizable number of recent-vintage subprime
loans experience their first interest rate resets.

He explained that on average, from now until the end of 2008, nearly
450,000 subprime mortgages every quarter were scheduled to undergo their
first interest rate reset, and that the resulting payment shock would be
compounded by the decline in home prices and a tightening in lending
terms. A sharp increase in foreclosed properties for sale, he said,
could also weaken the already struggling housing market and thus,
potentially, the broader economy.

Bernanke related the housing and mortgage crisis to the crisis in credit
markets by explaining that while in the past most mortgages were held by
the companies that originated them, today mortgages are commonly bundled
together into mortgage-backed securities or structured credit products,
rated by credit agencies, and then sold to investors.

Commenting, in rather diplomatic terms, on the collapse of the resulting
edifice of financial speculation, he said, As mortgage losses have
mounted, investors have questioned the reliability of credit ratings,
especially those of structured productssuch as CDOs.

Since no one really knows the value of these assets, the loss of
confidence in the credit ratings... led to a sharp decline in demand for
these products. In other words, banks and other financial institutions
holding these securities are unable to unload them except at fire-sale
prices, leading to potentially catastrophic losses on their balance
sheets.

Bernanke went on to say that the collapse in confidence in
subprime-backed securities had spread to virtually every sector of the
credit markets, including securities backed by jumbo mortgages to home
buyers with good credit and commercial paper traded between
corporations. The market for leveraged buyouts, which had largely
fueled the stock market boom of the last few years, had dried up, and
banks were increasingly reluctant to lend to their customers and to
each other.

These events do imply, the Fed chairman said, a greater measure of
financial restraint on economic growth as credit becomes more expensive
and difficult to obtain.

The short-term result, Bernanke said, would be a further contraction in
housing-related activity and a slower growth in household spending.
Overall, the Fed expected that the growth of economic activity would
slow noticeably in the fourth quarter from its third quarter rate.
Putting an optimistic face on a dire situation, he said that growth,
while remaining sluggish in the first part of 2008, would strengthen as
the effects of tighter credit and the housing correction began to wane.

However, he acknowledged the downside risks of a worsening financial
crisis causing credit conditions to become even more restrictive than
expected and a more-than-expected weakening of housing prices, which
could further reduce consumers willingness to spend and increase
investors concerns about mortgage credit.

He also spoke of the upside risks of sharply higher inflation from
soaring oil prices and a continuing weakening of the dollar.

He concluded with his standard statement that the Fed would continue to
carefully assess the implications for the outlook of the incoming
economic data and financial market developments and act as needed to
foster price stability and sustainable economic growth.

The initial response on Wall Street to Bernankes testimony was a sharp
fall in stock prices, with the Dow Jones index slumping more than 200
points. However, by the end of Thursday the Dow had recovered most of
its losses, closing down 33.7 points. However, the technology-laden
Nasdaq fell 52.76, or 1.9 percent. This was largely due to a negative
projection from the networking giant Cisco, whose shares fell 10
percent, sparking a broader sell-off of hi-tech stocks.

The recovery, particularly in banking and financial stocks, may have
reflected a consensus that Bernankes report was so dismal as to suggest
a third successive interest rate cut when the central banks Federal Open
Market Committee meets next on December 11. While many on Wall Street
continue to clamor for rate cuts, in the hope that an expanded flow of
cheap credit will save them from the consequences of years of financial
manipulations and outright swindling, such an action can in no way
resolve the mounting crisis of US and global capitalism.

In the short term, it will only intensify the crisis of the dollar and
fuel the conditions for rampant inflation. More fundamentally, such
policies compound the underlying instability and insolvency of the
financial system.

Bernankes own testimony points to an inevitable reckoning, in which the
vast global economic imbalances, the inherent anarchy of the capitalist
market, and the rampant parasitism, of American capitalism in
particular, produce an economic and social disaster.