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Sent: Saturday, March 11, 2006 8:27 PM
Subject: The Fed Officially Kicks Off the Next Recession
>
>
>
>
> March 12, 2006
> The Fed Officially Kicks Off the Next Recession
> by Robert McHugh
>
> It is official. A recession is coming. How do I know?
> Because this week new Fed Chairman Ben Bernanke gave an
> official warning to bankers about commercial real estate
> loans. That is always the kickoff to a recession. It is the
> starter's gun, the national anthem before a ballgame, the
> opening hymn at a church service. Here is how it works. The
> Fed has three official tools to control the money supply:
> Setting reserve requirements (telling banks how much of
> their deposits they cannot lend. The higher the reserve
> requirements, the less loans, the less money creation by the
> economy). The second tool is open market operations. Here
> they set the amount of money in the system by buying or
> selling securities. Third is setting the discount rate, the
> rate of interest banks must pay to borrow money at the Fed.
>
> Theoretically, the higher the rate, the less money banks
> will borrow, the less they have to lend, and the less money
> that is created by the banking system.
>
> However, there is a fourth tool, a stealth tool, which has
> more power and impact than the other three. It is called the
> Federal Reserve Bank examiner.
>
> He/she is the person who goes into a bank about once a year
> and decides which loans are good and which are bad. Based
> upon their holy edict, a loan is classified in one of
> several categories which determines how much money the banks
> must set aside from earnings to reserve for possible losses.
> It is completely an estimation game. So the rules can and do
> change, based upon the whims of the examiner, taking his
> marching orders from the Fed Chairman.
>
> If the Fed wants the money supply to expand, then Fed
> examiners come in with reasonable standards for review of
> loans, and classify those loans with a general leaning that
> they will be repaid according to terms. Thus banks do not
> have to reserve as much for possible estimated losses and
> are in effect not discouraged from making more loans. When
> the Fed wants money supply to grow, aggressive lending
> standards often get passing grades. That's when you business
> people will see your friendly bank commercial lender more
> often, jawing you into that expansion project you've been
> thinking about, inviting you to golf outings and ball games.
> They want more loans. They need your expansion project.
>
> However, once the Fed Chair sounds the alarm about
> commercial real estate loans, it starts an entire chain of
> events that ultimately and unequivocally leads to economic
> recession. Here's what happens. Out of the blue (that seems
> to be a favorite modus operandi for all Fed operations)
> those friendly back-slapping Federal Reserve examiners (not
> really, they are never overly nice -- okay I've met two or
> three out of a pool of three hundred -- Mike, Eddie, Eric,
> you know who you are and I know you read my stuff) show up
> with a scowl that droops like the golden arch. They ask for
> the files, a table, an outlet, a coffee pot, and the key to
> the little boys and girls room.
>
> About two days after they arrive, the banker knows something
> has changed, something serious, and he gets this knot in the
> pit of his stomach that will last for about three years.
> Examiner Margo asks for a meeting with banker Joe. She
> brings her supervisor to raise the fear level of the
> meeting. The Bank's President, Joe, brings his top
> commercial lender for protection of his fanny, and that
> lender brings his junior lender who will ultimately be the
> sacrificial lamb and get the ax should things blow up.
>
> Bottom line: Margo feels that a good commercial real estate
> loan, paying on time, plenty of collateral, doesn't quite
> throw off enough cashflow on its financial statements in
> file, and is now suddenly rated below satisfactory.
>
> Not quite doubtful. What this means is the banker now has to
> set aside 20 percent of the loan in reserves for possible
> losses. That reduces income, and he has a big one-time hit
> coming to earnings this quarter. The banker defends the loan
> with dexterity -- he has to fight back, but cannot tick them
> off too much as they hold all the cards -- but the
> discussion is going nowhere. Finally Margo's supervisor,
> Lead Examiner Harry, whose head hasn't moved an inch -- just
> his eyes, rolling back and forth from speaker to speaker --
> drones out, "This loan is less than satisfactory," then gets
> up and goes back to his room full of tables, laptops, and
> loan files. This goes on for days. Toward the end of the
> examination, about a month later, they bring out the heavy
> artillery. More senior examiners from the regional office
> arrive and the meetings get larger and longer as
> satisfactory loans have now been declared doubtful, and
> doubtful loans are now downgraded to total loss. They
> especially target commercial real estate loans. First ones
> to go. Again, nothing regarding the loan itself has changed,
> the game is one of judging the subjective quality of the
> loans, and for no apparent reason, the subjective quality of
> myriad loans has remarkably deteriorated. The banker is left
> with a list of suddenly crappy loans in his portfolio, and a
> required loan loss reserve that is about 80 percent higher
> than he has on the books. He is then told in a wrap-up
> meeting that because of this "loan quality problem" in his
> bank, his bank's overall rating has been dropped from a 1 to
> a 2 or a 2 to a 3 (banks are rated 1 to 5 with 1 being the
> best.
>
> Ratings below "2" get bank presidents fired. Ratings below 3
> get the Chairman of the Board of Directors removed, with
> lots of fearful warnings to the Board of Directors of the
> bank about Director liability and civil money penalties).
> This rating is confidential, with criminal prosecution
> should the banker reveal it. In fact everything in the
> examination report is confidential, with criminal penalties
> should he reveal its contents. There is no appeals process.
>
> Needless to say, after the examiners pack up their
> newspapers, laptops, and locked suitcases, the banker and
> his crew of commercial real estate lenders are left in
> shock. The Board of Directors gets a visit about a month
> later from the Head examiner and the top Regulatory folks at
> the regional Fed office. If they bring someone from
> "Washington D.C.," then the bank President and Senior Lender
> are toast. The Board of Directors politely listen as the
> Head Examiner and his boss cite every blemish and foul found
> in the place with smiles intermittently flashed with icy
> stares, a game of intimidation. Warnings are given, then the
> Fed folks get up, make sure they shake everybody's hand in
> the room as if its "business, not personal," and leave.
>
> At the end of the day, a junior lender gets canned, the
> Board steps up the heat on the President to do something
> about this, and banker Joe and his senior lender immediately
> decide to stop making commercial real estate loans.
>
> For the economy, this means a credit crunch has started.
> Expansion stops.
>
> Willing buyers can no longer obtain financing to buy
> properties. This reduces demand for properties at the exact
> same time bankers are encouraging these suddenly classified
> borrowers on their books to sell their properties and pay
> back the loans. This increases the supply of properties for
> sale at the exact wrong time, lowering prices.
>
> But the black hole is just getting started -- just beginning
> to suck the economy into the abyss. What I outlined above is
> merely round one.
>
> About six month later, property values have dropped from
> this excess of supply and lack of demand due to the
> curtailing of bank commercial real estate loans. This means
> the collateral values of the loans on the bank's books have
> declined.
>
> Another Fed examination is scheduled, they are back in, and
> with the battle well under way, it is time for these public
> servants to start shooting the wounded. They are fully aware
> that property values have dropped, and -- ignoring the fact
> that they caused them to drop -- they march to the file
> room, grab their favorite previously classified loans, and
> get to work. They assign the most experienced examiners to
> review the classified loans while they send the rookies to
> find potential problems among the previously good loans. But
> the action is with the classified bad boys.
>
> That loan they rated less than satisfactory because of
> cashflow problems the last time they were in has now
> deteriorated to doubtful because of the compounded affect of
> collateral undervaluation. That means instead of setting
> aside 20 percent of the loan amount into the reserve for
> possible losses, banker Joe must now set aside 50 percent,
> another big hit to earnings. He had promised the Board of
> Directors that last year's one-time hit for potential loan
> losses would be a one-time occurrence. He realizes that is
> not the case, and begins to wish he had become a UPS
> delivery man.
>
> At the end of the day, the bank's rating has dropped, the
> Board is scared about Director liability, and Joe is pulling
> out every political favor he's accumulated among a majority
> of the Board to keep him around for one more year. He agrees
> to sacrifice the bank's Senior Lending officer, who has
> served as a shield the past year, not making loans, but
> sitting in his office, ready to be ejected for the good of
> banker Joe's considerable stock options portfolio and other
> bennies that come with holding on to a bank presidency for a
> decade or so. The senior lender is replaced by a credit
> hack, someone with no people skills, adept at strong-arming
> bank borrowers into paying back the money. The goal is to
> shrink the loan portfolio by not making new ones, using the
> normal cashflow from payments to reduce outstandings, and to
> sell at a discount or coerce partial payments from existing
> loan customers who were rated unsatisfactory by the Federal
> Reserve's finest. This means lawyers get involved, lots of
> lawyers, skilled at scaring borrowers into "working out"
> loan repayments with this new nasty bank lender. This means
> less money is available for potential buyers of property in
> the economy, more distressed sale supply hits the market,
> and real estate values fall even further.
>
> It is about now that everyone recognizes a recession is well
> underway, led by a real estate collapse. The truth of the
> matter is, the rules were changed by the Fed and nobody was
> told until it was too late, and the economy plunges. Voters
> scream, a few politicians get tossed, and the phrase "credit
> crunch" becomes a darling of the media. It takes action by
> the President of the United States to haul in the Federal
> Reserve Chairman, and explain to him the reality of the
> reappointment process every four years.
>
> Suddenly, at the next bank exam, a new friendlier,
> examination teams shows up, drinks more coffee, has a few
> extra newspapers tucked next to their laptops, are asking
> for fewer files, complain they have to rush to another job
> in two weeks so won't be there as long as the last time, and
> leave with little fanfare. The bankers are told in the
> wrap-up meeting, that they've improved their loan quality,
> the bank's rating is boosted one grade, and all is well with
> the world -- end of recession.
>
> On March 8th, 2006, Federal Reserve Chairman Ben Bernanke
> announced at the Independent Community Bankers of America
> conference, "The rapid growth in commercial real estate
> exposures relative to capital and assets raises the
> possibility that risk-management practices in community
> banks may not have kept pace with growing concentrations and
> may be due for upgrades." Fed examiners are warming up their
> laptops. The barbarians are headed for the gates.
>
> The Fed announced again on March 9th, with no palatable
> explanation, that they will no longer publish M-3 as of
> March 23rd. While they claim that M-3 is useless, in the
> blurb on their website, the fact is banks are still
> reporting all the data on their Call Reports used to
> calculate M-3. The Fed has not eliminated the unique M-3
> components from the Bank Call Reports.
>
> Why don't they want to be transparent with the most
> important statistic, the very measure of why they were
> established by a minority of Congress during a late night
> session back in 1913? Because they cannot wait to pump money
> to high heaven like some sort of fiat tower of Babel.
>
> M-3 was increased by $28.3 billion last week, a 14.2 percent
> annualized rate of growth. Over the past 2 weeks, M-3 was
> boosted an amazing $81.9 billion, for an annualized rate of
> growth of 20.7 percent! Over the past 8 weeks, M-3 is up
> 129.6 billion, an 8.2 percent rate of growth, and is up a
> whopping $249.7 billion over the past 12 weeks, a 10.7
> percent annualized rate of growth, a $1.0 trillion annual
> expansion.
>
> What is happening here? How does this reconcile with the
> Bernanke announcement that bank commercial real estate
> lending will be curtailed?
>
> There are two ways for the money supply to grow. First is
> through the bank lending function. The more lending, the
> more spending, the more bank deposits, which is at the core
> of the money supply definition. The Fed has apparently
> decided to slow the velocity of money creation by slowing or
> shutting down lending. However, the Fed knows it needs money
> to buy financial markets and monetize our debt. The lending
> function is too much out of the direct control of the Fed.
> In other words, money is created that way, however the Fed
> doesn't get to decide where that money goes. It is going to
> businesses for expansion and jobs, etc... No, the Fed wants
> to decide where money goes. So it will replace money created
> through the lending function with money created from thin
> air by the Fed itself. The way for that electronic money to
> enter the economy will be from the Fed directly buying
> something, or lending money to someone. In effect, the
> Master Planners will decide where fresh money goes. They
> will control more of the spending. But they cannot let us
> know this. Because it would be too easy to prove they are
> doing this if M-3 remains transparent. You would simply
> compare commercial and consumer loan data to the M-3
> figures. If we saw debt declining but M-3 rising, voila, we
> would clearly see the Fed is directly pumping and funneling
> that money someplace, which would beg the tough question,
> where? You can bet most honest, patriotic, free-market
> Americans would not appreciate the answer.
>
>
>
>
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