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Thursday, January 24, 2008 3:30 PM

Banks Attempt To Freeze Balance Sheets

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Echoing what I said days ago in Fiscal "Stimulus" Doomed To Fail, MSNBC is reporting Impact of bold Fed rate cut may be limited.

While the move helped slow a global slide in stock prices Tuesday, the long-term economic impact of cutting interest rates may be limited.

Why? To paraphrase an old campaign slogan, it’s the housing market, stupid.

Even as housing starts continue to fall, the inventory of unsold houses has risen. With prices falling in many parts of the country, buyers are waiting for a turnaround before they start house hunting again.
My Comment: Therein lies the first key. Psychology is a major driving force. Consumers have decided home prices will keep falling. And as long as home builders keep building at a pace greater than sales, inventories will continue to rise and prices will continue to fall. As the recession steepens, massively increasing numbers of foreclosures will exacerbate the problem.
Lenders and investors have already written off roughly $100 billion in losses so far. But no one knows how much more debt will go bad — or who is holding the bad paper. So even after the Fed has flooded the system with money, lenders remain tightfisted for fear that the borrower won’t be able to pay back the loan.

“Large money center banks have virtually frozen their balance sheets, reluctant to lend even to good credit,” Scott Anderson, a senior economist at Wells Fargo Economics, wrote in a note to clients Tuesday.
My Comment: Therein lies the second key. Banks are unwilling to lend. Now we see a significant change in psychology on part of both consumers and lenders.

However, banks did not freeze balance sheets. Rather they are "attempting" to freeze balance sheets. They are failing in the mission because rising foreclosures are forcing assets onto the balance sheets in spite of a decreased willingness to lend.

Citigroup (C), Merrill Lynch (MER), Lehman (LEH), and Morgan Stanley (MS) all have had to sell assets to shore up balance sheets.

Capital Impairments in the Eurozone

Capital impairment problems are not isolated to the US. A Rogue Trader caused a $7.2 Billion Loss at Société Générale by making massive futures bets that markets would rise. Now Société Générale needs to increase capital by €5.5 billion in the "following weeks."

Reluctance to Lend Hits U.K.

The Times Online is reporting UK mortgage approvals fall to 11-year low.
The British Bankers' Association (BBA) today show the number of home loans granted by lenders fell from the previous month's 43,944 to 42,088 approvals in December — the lowest since 1997.

The record fall is 22 per cent below the six-month average and 37.8 per cent below December 2007. Gross mortgage lending also declined from £16.5 billion in November to £15.1 billion.

Lenders have become much more cautious about whom they lend to after the emergence of the sub-prime mortgage crisis in the US, where companies granted home loans to individuals with a poor credit record.
The above are not isolated incidents. There is systemic capital impairment and increased risk aversion everywhere you look, on the part of consumers and banks alike. This is where the hyperinflation theory falls flat.

Those wishing to review both sides of the debate however, may wish to read Not Your Father's Deflation: Rebuttal and Peter Schiff Replies to Deflation Rebuttal.

In the final analysis, deflation is all about risk taking and psychology (the ability and willingness of consumers to borrow and the ability and willingness of banks to lend). Right now Bernanke specifically, and central bankers in general, more than have their hands full in this regard.

However, hope springs nearly eternal. Thus Faith In The Fed May Be The Last Bubble To Pop.

Mike "Mish" Shedlock
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