As I write, Henry Paulson, Secretary of the Treasury of the United States is, in proposal, suggesting a one-world-government.
Surprise, surprise, surprise!
Mr. Paulson established, only weeks ago, a corporate socialist nation as the future for the US. Now, to keep from exposing the lie of how deep the losses created by the removal of Glass-Steagall 1933, he, and President Bush, are ready to cede decision making processes among all things financial to a world body. Yes, this includes what the US does within its own borders, as well.
Today, and continuing through this Columbus Day Weekend, the G7, and G20, respectively, are meeting to coordinate efforts in attempts to stem the collapse of the global financial system. Mr Paulson has agreed to adhere, and bind the US, to any solutions the group develops.
All of which will be in vain. The banks cannot reasonably trust one another, for the simple fact no one knows who is solvent, and who is bankrupt. Until all financial institutions are forced to declare exactly what is on their balance, and off-balance, sheets, and its exact value, no one will loan anyone a penny, unless they pay dearly for it.
Most of the world blames the US.
For all of it.
I guess it is only right. We have delivered havoc to other countries, wholesale. Our investment banks, once the pride of the global financial world, have created financial instruments, which, at their heart, were nothing more than smoke. These instruments were predicated on the belief that prices could never go down as long as regulation and oversight were made ineffective.
De-regulation, belief in ever-increasing prices, and the idea America could transform herself from manufacturer for the world, to banker of the world, allowed the US to develop hubris and sanctimony unrivaled in the modern era. Those who developed and championed this ideology forgot to add one variable to the equation - greed. Most assuredly it is hard to measure greed, yet should it not be accounted for, since it is quite possibly the most dominant variable?
Evidence I am correct is only a slight read away. Derivatives - do you know what they are? Mark to market versus mark to model - explain that to your children. Level 3 accounting - wish my bank allowed me that privilege. Supply-side economics - only with deficits supported by foreign purchases of our Treasuries. All of these things together created false wealth, at dizzying speeds. The second the wind blew enough to cause one card to quiver, those above it began to fall, until the whole house was in danger.
Now the real power grab begins. Trust this, the big banks that survived the Great Depression already have a blueprint to follow. The Federal Reserve will now rule this country, no matter who you vote for. The most powerful man in the world will, for a short time, be the Chairman of the Federal Reserve. Within twenty years, someone in a similar role in China may well have that honor.
You must understand - The Federal Reserve does not bow to the President, it bows to its shareholders. The CEO's at the heads of the companies that own the most Treasuries held by the Federal Reserve are who every real American should come to know. To not know means your vote is a puff of smoke in a hurricane.
Maybe we like it that way. The world has become a very complicated place. Politics are mere deflections by their very nature in this new world. One against the other, sic et non. The media is now engaged in a desperate fight against and amongst itself. So caught in the fight to represent one side or the other, the voices of sense and reason are drowned amidst the vast ocean, like a person overboard. Should the sole swimmer reach eager ears, sharks, by the hundreds, devour the voice, until even the whimper is only memory.
How much more can you bear? $800+ Trillion in derivatives, all bets, on the performance of an underlying $30 Trillion, that has lost at least 20% in value. So - A minimum of $160 Trillion in losses... and counting. These losses are already gone forever, they cannot come back. Should housing values continue to drop, the losses grow.
There is a solution. All institutions must eliminate level 2 and level 3 accounting. All financial instruments must be marked to market, no exceptions. This will restore confidence on who is solvent, and who is not. This is at the heart of the "liquidity" problem. No one trusts anyone else.
Yes, some firms will be insolvent, maybe quite a few, but the government could then step in to recapitalize them, after their derivatives have been cleared off the books. They would be much smaller, but if they are that smart, they will grow again. As Karl Denninger writes:
"If there is recovery value (in most cases there will be, as we saw with Lehman) then the bondholders get newly-issued equity in ratable proportion to their (former) ownership of the bonds. The existing equity is wiped out. The firm, having no balance sheet debt whatsoever, can then immediately raise capital in the market to recapitalize itself (having a clean balance sheet this is a trivial task)
For those firms that have zero equity remaining, the government can step in and inject capital via a super-senior tranche as necessary to establish a working capital base. Remember, with a 6% Tier 1 capital requirement a little goes a long way - $10 billion injected results in over $160 billion of available gearing! Bingo - the firm is back on its feet. Protect the taxpayer in these transactions by attaching an onerous coupon to the issue so that it will be rapidly repaid (e.g. 3mo LIBOR + 600 bips) and cleared.
The objection to this plan will be that existing equity holders will be wiped out and bondholders will take a haircut.
Well, bond holders are no worse off than if the firm went under. They would get their recovery value anyway, and they still do - its just in the form of equity instead of cash.
As for equity holders, they're wiped out in a bankruptcy too.
The real objection to this is going to come from the executives, who will see their stock options rendered worthless along with their restricted shares. However, they remain in place (if the shareholders will have 'em) and as a consequence can rebuild their equity over time."
Leverage must also be returned to sustainable levels. Bear Stearns, Lehman Brothers, Wamu and others all had borrowing levels that exceeded capital by 30 or more times.
Most of all, these suggestions will not require one dime of taxpayer money be exposed to losses. The bailout last week will end up increasing the Federal deficit by trillions. The bailout does nothing to restore confidence in inter-bank lending as evidenced by action in LIBOR this week, and it does nothing to stop a firm from going under.
Any further actions that do not resolve the underlying issue of who has what losses will be futile. Any money put into action without solving who has what losses will be lost, in entirety.
Should no group stand up and demand that Mr Paulson stop, our great nation will take a step most Americans may not agree with. Unless, you believe a few more dollars, in the very short term, is a fair trade for sovereignty.
5 comments:
why is the 800 trillion bet the issue? if a bond fails, how come its loss is more then face value?
All of the derivatives are considered bonds. Almost all of them had a AAA rating when issued. The bets I am referring to were considered bonds at the time the investment banks sold them.
MBS are derivatives of the first order.
Derivatives of the second order (CDO's, CLO's, CMO's, HIV's etc) and derivatives of the third order (CDO's squared)are nothing more than positive bets on the performance of the derivative of the first order.
What that means is if the derivative of the first order goes negative (loses its rate of return) the "bet" represented by derivatives of the second and third order are lost in entirety.
So far, it is not a total loss, due to the slices, or tranches. Each derivative of the first order will contain as few as 4, or as many as 8 tranches. Each tranche represents debt (mortgages for MBS) of a similar nature. One tranche in a MBS may be all first lien ARMs originated in Sept 2006. Most MBS had tranches of low risk loans (30 yr fixed prime) and high risk (100% ARM AltA). The high risk tranche raised the overall rate of return for the MBS.
A CDO was then assembled containing 2, 4 or more MBS. The rate of return for the CDO is calculated by how much return was represented in the underlying MBS issues. More tranches of higher risk meant higher rates of returns, which generated more fees when sold.
As a tranche in the MBS goes bad (Jun 2004 100% ARM subprime), the MBS still gets some rate of return for the mortgages in that tranche which are still being paid. That tranche in the CDO is a 100% loss.
Remember, the CDO is nothing but a complicated bet on the positive performance of the MBS.
If a house goes into foreclosure, the MBS that owns that debt is first in line for relief (through the servicer). The CDO gets nothing. Owners of a $1.2 Billion CDO issued by Deutschebank tried to sue in court in Cleveland to get the proceeds from short sales and foreclosures sales from the properties represented in their CDO. When the judge was told what the CDO was, he laughed and tossed the case out. The Judge ruled the MBS owns the mortgages, not the CDO.
As housing prices continue to fall, the losses are magnified. I am being overly simple, and overly optimistic, to think the losses are only $160 trillion.
Let me put it this way - Last Friday, a judge ruled that the average value of derivatives issued by Lehman Brothers was worth less than 10% of their original value.
There are much larger players than Lehman in derivatives.
thank you
i enjoy your articles. given "this will end very badly" waht do you see happening to the market/economy given the derivative problem?
Not to get too depressing or cynical, I will simply say we are no where near a bottom.
To reach the bottom, several things must happen. 1) Housing values, as indicated by historical norms, must be somewhere between 2.5 - 3.5 annual wages. That is a fading trick in an environment where the number of unemployed may double over the next year or so.
2) All corporations must be forced to mark to market all their holdings.
3) The government must stop and rescind all lending facilties that require use of newly printed Treasuries.
The market will continue to be controlled until all these things are accomplished. As long as the market is controlled, money will continue to concentrate to those at the top.
We also will not know how deep the losses until these things happen. Many household names will not survive this.
The more games that are played, the greater the burden to our national debt. People think it can't get worse than the 1930's. Right now, I am not so sure.
Our economy was 70% consumer driven over the last 8 years. The consumer is, in the near term, no longer able to spend. Everything reliant on consumers taking equity from their homes and putting it into the economy will suffer. Unfortunately, that is our reality, and will continue to be until we build a sufficient manufacturing base with wages equal to those jobs being lost in the financial sector.
That will take years.
Post a Comment