"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Friday, September 24, 2010

A Threat to the US Dollar - potential Banking Armageddon Part II

The US Banking Crisis is far from over.  The crisis that intensified in the Autmumn of 2008 has only been delayed, not resolved.  Tough decisions will likely be made in the future regarding the housing market, and its effects on bank capitalization and US Municipal budgets.  Eric King, of King World News interviewed Christopher Whalen (bio and interview link) recently.  Some of the points made by Whalen in the interview:

1) He mentions Lori Goodman of Amherst Securities and a recent presentation where she estimated that one in five residential properties in the US could go into foreclosure.  Whalen then mentions that over half of the banking industry's portfolio is real estate exposure, and even higher if you include the off balance sheet securitization.  Thus, if the one in five foreclosure figure materializes, then as Whalen puts it: "We're talking about gutting the banking industry's capital, and that's a very serious issue."

2) Holding companies should have been put into bankruptcy and restucterd with the government and FDIC as parties.  But the Administration - Summers and Geithner, didn't want to do this, so now we're "muddling along, we have no credit for the economy, and we have three perhaps, four big banks, that have serious problems."

3) This real estate driven bank balance sheet crisis will likely be the cause of the next big banking crisis.

4) Ultimately, the government will get involved again and will restructure these banks, basically, what they're doing in Europe, in a year or two year's time.

5) "What we're facing now, is an order of magnitude bigger than what we went thru in the 1990s, which almost swamped some of the best."

Other topics covered:  The Washington-Wall Street relationship, Housing vs. Manufacturing as an engine of future growth, the securitization/imperfect recordation nightmare, and effects on the revenues of cities and other local governments.  In the US, local governments raise revenue by taxing real estate.  As more homes fall into foreclosure, and others get abandoned by some lenders, municipal tax revenues plummet.

Link to Interview

My view:

So how is this a threat to the US Dollar?  It all depends on how the crisis is resolved.  Will the Federal Government proceed with debt monetization, i.e. the same strategy it has been pursuing?  Will the Federal Reserve start quatitative easing again?  Or will the government get involved as it did in the Savings and Loan Crisis of the early 1990s as Chris Whalen suggests?

Either way, what does this mean to the US Dollar?  There are additonal crisis that arise from a banking and foreclosure crisis.  Will the US Federal Government bail out bankrupt municipalities?  What happens to Pension Funds and other bondholders that may ultimately lose a significant amount of their investments?

I fear a chain reaction of predictable and unpredictable consequences is unavoidable.  The end result will be damage to the US Dollar with severe implications to the global economy.

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