Geithner's Second Wave May Be A Tsunami

"We're not going to have.... a second wave of financial crisis..... We'll do what is necessary to prevent that.......and that is completely within our capacity to prevent."

The above statement was made by Treasury Secretary Timothy Geithner when interviewed on NPR's "All Things Considered" program in the last few days.

Apart from the Treasury Secretary's dismal record to date, there are three problems with his statement:

• The phraseology indicates that a second wave is coming and
• He does not spell out what he would do if the second wave did appear.
• Finally, if the Fed cannot spot bubbles forming in the economy, what chance does it have of spotting waves when its back is turned on the ocean?

Had Mr Geithner been confident of the measures to date he would have said, "the improvements in the market quite clearly indicate that a second wave is not on the cards." Instead he simply says that they have the capacity to prevent it. He of course cannot spread panic by blurting out the truth, but in the same interview he says:

"We were in a very deep hole and it is going to take a long time to repair the damage done to confidence."

With all due respect to the Treasury Secretary, the US is still in a very deep hole and apart from damage to confidence he can also add damage to share portfolios, property values, unemployment and five thousand other things except bankers' bonuses.

But how does he propose to avoid a second wave turning into a tsunami when the US is already below sea level?

Will he take on more toxic assets onto the Fed's balance sheet arising from crashing commercial property values?

Will he increase employment by sending more citizens to foreign theatres of war or will he add to the 2.2 million jail population of the USA who are not included in the unemployment rate?

Will he hand out more stimulus by printing more money or does he believe that foreigners will continue to make available their shrinking US dollar surpluses to him?

To be honest with you Mr Secretary I cannot see any lighthouses or lifeboats at this point in time. In fact the means the government has employed to date remind me of the band on the Titanic that kept playing as the ship was going down so as to keep the passengers calm.

But as the old saying goes, "words speak louder than actions." On Christmas day Bloomberg reported that the U.S. Treasury would remove the caps on aid to Fannie Mae and Freddie Mac for the next three years so as to allay investor concerns that the companies would exhaust the available government assistance.

Now why would they do that if the property market is getting stronger? The answer is that the market is not getting stronger. On Wednesday last week the cat was let out of the bag when it was reported that sales of new homes had dropped by 11% to an annual pace of 355,000. Crazily enough the sale of used homes had come in above expectations the day before. What would you expect if 33% of the sales were foreclosures? If you don't believe me, then check with the National Association of Realtors.

The bottom line is succinctly provided by Julian Mann who helps oversee some $5.5 billion in bonds as a vice president at First Pacific Advisors LLC in Los Angeles:

"They don't want the foreclosures now, so they're saying, we'll pay whatever it takes to continue to kick the can down the road."

I therefore ask every reader, "Why, would the above measures be taken if a second wave was not expected?"

The short answer is that Mr Geithner is not only powerless to stop a second wave, he is also contributing to that wave morphing into a tsunami. In other words we are seeing more of the same paper transfusions we have seen to date.

The days for allowing losses to be flushed out in an orderly fashion have almost gone. The bus without brakes has now picked up speed as it descends the slippery slope to disaster. There is a limit to how much brake fluid can be used and even what brake fluid can do when the brakes are gone. Messrs Geithner and Bernanke must level with President Obama and embark on forced liquidations of unpayable debt and insolvent entities. What remains will flourish and provide the systemic renewal that is presently denied due to stimulus, relaxed valuation rules, opaque accounting and quantitative easing. Feel good measures must now give way to make good measures before the remaining strengths in the economy are contaminated.

Above all, the crazy imbalance in income distribution that has manifested itself over the last 10 years must be recalibrated or the system will implode. Trickle up is manifestly more powerful than trickle down in jump starting an economy. Giving bankers massive bonuses will do much to enhance asset speculation and very little to increase the velocity of money in the productive economy. The bankers need to realise that they are in shark infested waters and that any attempt to hold onto their rewards just for themselves will ultimately see them sink or being eaten alive.

Failure to change course, strategy and emphasis may well see a state of emergency being declared at some point where the entire stimulus will have to be spent on riot control and detention of exasperated citizens. This cannot be the path for a democratic nation that is also a super power.

I repeat, do not be fooled by the music of continued stimulus spending. At some point (whether tomorrow or in 5 years time) it will cease and the rush to the doors marked "gold" and "silver" will be furious. Make sure you are close to the exits in the New Year. The rising price of these metals is like the rising level of water, so do not ignore the signs.