Banana Republicans - Part 2

U.S. banks increased sales of insurance against credit losses to holders of Greek, Portuguese, Irish, Spanish and Italian debt in the first half of 2011, boosting the risk of payouts in the event of defaults.

Guarantees provided by U.S. lenders on government, bank and corporate debt in those countries rose by $80.7 billion to $518 billion, according to the Bank for International Settlements. Almost all of those are credit-default swaps, said two people familiar with the numbers, accounting for two-thirds of the total related to the five nations, BIS data show.

The payout risks are higher than what JPMorgan Chase & Co. (JPM), Morgan Stanley and Goldman Sachs Group Inc. (GS), the leading CDS underwriters in the U.S., report. The banks say their net positions are smaller because they purchase swaps to offset ones they’re selling to other companies. With banks on both sides of the Atlantic using derivatives to hedge, potential losses aren’t being reduced, said Frederick Cannon, director of research at New York-based investment bank Keefe, Bruyette & Woods Inc.

“Risk isn’t going to evaporate through these trades,” Cannon said. “The big problem with all these gross exposures is counterparty risk. When the CDS is triggered due to default, will those counterparties be standing? If everybody is buying from each other, who’s ultimately going to pay for the losses?”

  Bloomberg

Well, I think we know.

Financial institutions, such as US banks, that sold “swaps” on Greek bonds were gambling that Greece would be bailed out and would not default. The financial institutions regarded as gravy the fees paid to them for “guarantees” on which they cannot make good. I don’t know the extent of swaps on sovereign debt, but I recently saw a report that the Bank of America alone has sold $2.1 trillion in swaps on sovereign debt. Imagine the crisis if the Bank of America had to pay off these swaps.

[...]

The Federal Reserve and the US government have ruled out permitting the banks to fail. That leaves inflation.

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[W]ith consumers too indebted and broke to borrow and the consumer market too impaired for good sales prospects for businesses, what profitable prospects do banks have? Only those created by the Federal Reserve’s support of the “carry trade,” the ability of financial institutions to borrow from the Federal Reserve at essentially zero interest rates and to put the money in Greek and Italian sovereign debt. This is gambling, otherwise known as “casino banking.”

  Paul Craig Roberts

The European Union must be thrilled. Bernanke may not really be in danger visiting Texas, as Rick Perry insinuated, but he probably shouldn’t be traveling to Europe.

The main difference between Greece’s indebtedness and America’s is that Greece cannot print euros, but the US can print dollars. Thus holders of US debt can always get back the nominal dollar value of Treasury debt issues. Of course, the real purchasing power of these printed dollars can be very low.

[...]

It seems that the path that policymakers are taking is to reduce the purchasing power of money in order to drive up nominal asset values so that they exceed the claims against them.

For example, consider a person with a $200,000 mortgage whose home, if he could sell it, is only worth $175,000. This person’s asset is under water. However, if inflation drives up the price of his home to $250,000, the person has gone from a balance sheet $25,000 in the red to one $50,000 in the black. It seems clear that in order to save the financial institutions and itself, the government will sacrifice the purchasing power of the dollar.

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Sooner or later the Federal Reserve will be back to monetizing the new Treasury bond issues, that is, the Federal Reserve will create new money with which to purchase the new Treasury bond issues.

Sooner or later the new money will find its way into the economy and drive up prices, or the continual monetization of new US Treasury debt will cause the world to lose confidence in the dollar. Heavy sales of US dollars in currency markets would drive down the exchange value of the dollar and raise the prices of imports such as energy, manufactured goods, and food. Either way inflation is the result. Indeed, both can occur together, which is the likely result.

Normally, inflation is associated with a booming economy, but as too much of the US economy has been moved offshore, there is little left to boom other than prices. Therefore, the combination of high inflation with high unemployment is a likely fate that awaits Americans.

I cannot predict how long policymakers can hold economic armageddon at bay with spin, money creation, currency swaps, intervention in gold and silver markets, and outright lies. The onset could be sudden and take place this year, but we shouldn’t underestimate the power of spin over a gullible public that trusts “their” government and fervently believes that Muslim terrorists are out to get them and that the demise of the Constitution, the product of a eight hundred year struggle that produced Anglo-American civil liberty, is worth the price of “safety.”

There is no safety in a police state and a debauched currency.

...but hey, do what you want...you will anyway.