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TARP, Banks Exposure to Toxic Credit Default Swaps, Road to Nationalization

Economics / Credit Crisis 2009 Feb 05, 2009 - 12:07 PM GMT

By: John_Browne

Economics Best Financial Markets Analysis ArticleThis week, seven major corporations announced major layoffs, adding 72,000 to the unemployed. At the same time, lending by the big banks fell. With falling demand for loans, it is little wonder that President Obama described the national economic situation as "worsening day by day." Clearly, we are heading into a deepening and severe recession that is spreading worldwide.


As the reckless speculation of the major money center banks became clear in the second half of 2008, there was resistance to rescue efforts. However, the perceived wisdom was that these banks were too large to fail. Congress approved the $700 billion TARP to rescue them and the financial system. Now, there is growing demand by politicians for the banks to lend, in the face of falling loan demand. Clearly, a Democrat Congress is intent upon using Wall Street to dispense taxpayer funds to Main Street. This is socialism and strikes at the very heart of the 'American Way' of free enterprise.

Three major questions arise. Firstly, can the banking system be used to dispense cash to un-creditworthy citizens? Secondly, should the free-market banking system be used for political purposes? Thirdly, can the American government afford to bailout the collapsing economy and banking system simultaneously?

Acknowledging Tim Geithner's vow to employ "credit action on a dramatic scale", there is little doubt that the new Treasury Secretary thinks the banking system not only can, but will, be used to push taxpayer funds into the Main Street economy. If so, would this not necessitate nationalization?

The original TARP was designed to 'rescue' the banking system by relieving it of depreciating toxic assets. Subsequently, the TARP was used to inject capital into the main money center banks. So far, despite its enormous size, the TARP appears to have failed.

Contrary to political hopes, the banks are seen too have used the TARP selfishly (but rationally) to bolster their own capital and pay their own executives, whilst making fewer loans.

There is now an increasing specter of a massive bank failure, despite the TARP. As a result, there is growing pressure to nationalize the banks, as is being done in Europe. So far, Americans have resisted this option, but with Bank of America now trading below $5.00 per share, the temptation is growing.

In a recession, falling loan demand and deteriorating credit worthiness result in fewer loans worth making. There is mounting pressure, especially from Democrats, for banks to make 'social' or imprudent loans. Such actions are practicable only if the banks are nationalized.

Most Americans are firm believers in freedom and its economic progeny, the free enterprise system. But, under the cover of entitlement programs, increasingly large numbers of Americans are dependent, directly or indirectly, upon the Government.

In short, socialism is already alive in America, but is being extended, via the banking system, to become the dominant political force.

Citi and Bank of America, two of the three most important money market banks are technically insolvent. Yet, each has received $45 billion in TARP funds.

These two banks have total exposure of some $78 trillion to derivatives. Most importantly, they have almost $6 trillion of exposure to highly toxic Credit Default Swaps. Even JP Morgan has more than $9 trillion of exposure to these assets.

The Government TARP and stimulus packages now add up to some $3 trillion. Already, they have caused political consternation and pose serious challenges to America's credit rating and ability to extend further its towering debts, without crowding out viable corporate borrowing. What will happen when all of the private bank liabilities get thrown on top?

The money center banks render the TARP and, indeed, the total financing ability of the U.S. Government almost insignificant. In short, they have become too big to bail out.

It appears that America and the world are staring into the face of financial collapse, depression and eventual hyperinflation. Little wonder that, despite the growing evidence of recession, gold is rising in price.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read Peter Schiff's new book For an updated look at his investment strategy order a copy of his just released book " The Little Book of Bull Moves in Bear Markets ." Click here to order your copy now .

For a look back at how Peter predicted our current problems read the 2007 bestseller " Crash Proof: How to Profit from the Coming Economic Collapse ." Click here to order a copy today .

By John Browne
Euro Pacific Capital
http://www.europac.net/

More importantly make sure to protect your wealth and preserve your purchasing power before it's too late. Discover the best way to buy gold at www.goldyoucanfold.com , download my free research report on the powerful case for investing in foreign equities available at www.researchreportone.com , and subscribe to my free, on-line investment newsletter at http://www.europac.net/newsletter/newsletter.asp

John Browne is the Senior Market Strategist for Euro Pacific Capital, Inc.  Mr. Brown is a distinguished former member of Britain's Parliament who served on the Treasury Select Committee, as Chairman of the Conservative Small Business Committee, and as a close associate of then-Prime Minister Margaret Thatcher. Among his many notable assignments, John served as a principal advisor to Mrs. Thatcher's government on issues related to the Soviet Union, and was the first to convince Thatcher of the growing stature of then Agriculture Minister Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously pronounced that Gorbachev was a man the West "could do business with."  A graduate of the Royal Military Academy Sandhurst, Britain's version of West Point and retired British army major, John served as a pilot, parachutist, and communications specialist in the elite Grenadiers of the Royal Guard.

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