Fried Frenchies

As many Americans would hoot and howl about, France has joined China in vocally challenging the US to do something more than talk about the global economic crisis.

Nicolas Sarkozy has inferred he will walk out of the upcoming G20 summit if tougher financial regulations are not implemented.

From the Times OnLine;

"France will not accept a G20 that produces a “false success with language that sounds good but contains no commitments”, his advisers said. '

"The French threat dramatically raised the temperature hours before President Obama arrives in London today. If carried through, it would ruin a summit for which Mr Brown and Mr Obama have high ambitions, believing it vital to international recovery.'

"Mr Sarkozy, who blames the “Anglo-Saxons” for causing the economic crisis, told his ministers last week that he would leave Mr Brown’s summit “if it does not work out”. '

"Mr Sarkozy’s threat underlines the emerging splits between world leaders. Germany and France have led opposition to plans to coordinate public spending, championed by the Administration of President Obama."

Whether you consider this childish, or not, it is a growing indication the world is focused on real action to stem the current financial crisis. Many countries are at the breaking point, facing record levels of unemployment, unserviceable debt loads, shrinking exports and business closures. Drastic actions may soon become the norm if the world economy does not change course.

The US is not only the leading economic engine of the world, it is the leader of the world. Should we, in the eyes of our partners, fail to lead, we leave them with little choice but to seek alternatives.

FASB Caves In

More evidence the bankers are making the rules. In efforts to keep toxic assets hidden, the FASB, which was told by congress last week to ease up on Mark to Market, caved in and gave them what they wanted.

OH, ask not what you can do for your country, ask what a lobbyist can do for you.

From Bloomberg;

"The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities.'

"FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging from Bank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.'

“What disturbs me most about the FASB action is they appear to be bowing to outrageous threats from members of Congress who are beholden to corporate supporters,” said Levitt, now a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.'

The FASB has been considered one of the last hopes in forcing more transparency into the financial system. By strengthening mark to market rules, the FASB could have helped bring toxic assets onto active accounting ledgers, and the bloodletting from derivatives losses could then be dealt with. Not now. The new ruling not only allows the hiding to continue, banks will now be able to claim profit from what little cash flows still come from deteriorating credit derivatives, without acknowledging principal losses associated with downgrades.

".....Allowing companies to hold on to assets without writing them down could discourage them from selling the securities, which would work against Treasury’s objective to resuscitate markets, he said.'

“It’s one of the unintended consequences of having the FASB bow to political pressure,” Richard Dietrich said.'

"Conrad Hewitt, a former chief accountant at the SEC who stepped down in January, said representatives from the ABA, American International Group, Fannie Mae and Freddie Mac all lobbied him over the past two years to suspend the fair- value rule.'

"Executives “would come to me in the afternoon with the argument, ‘You’ve got to suspend it,’” Hewitt said in a March 25 interview. The SEC, which oversees FASB, would reject their demands, and “the next morning their lobbyists would go to Congress,” he said.'

‘Is That Fair?’

"At a March 12 hearing of a House Financial Services subcommittee, lawmakers showed impatience with FASB'

“You do understand the message that we’re sending?” panel chairman Paul Knjorski, a Pennsylvania Democrat, asked FASB Chairman Robert Herz.'

“Yes, I absolutely do, sir,” Herz replied'

"After hesitating, Herz said he would try to get a new fair- value rule finished within three weeks.'

“The financial institutions and their trade groups have been lobbying heavily,” Herz said in an interview after the hearing. “Investors don’t lobby heavily.”

"The political action committees of banks including Citigroup, Bank of America, Bank of New York Mellon, Wells Fargo and banking trade groups contributed money to Kanjorski’s re- election campaign last year, according to the Federal Election Commission. CitiGroup gave $6,500, Bank of America $7,000, Bank of New York $8,000 and Wells Fargo $13,000.'

"Kanjorski spokeswoman Abigail McDonough didn’t return calls seeking comment.'

This probably means the losses on credit derivatives will get deeper and deeper. Any CDO that is 50% of its original value today, may be worth half as much a year from now if housing values decline, and foreclosures continue. Since congress, and our Treasury, have committed trillions to saving the banks, these kinds of "hide the losses" games only benefit the corporations that created this mess. And the taxpayer is asked to assume the losses.

The US Legislative process has devolved into a system of lobbying. Only those that can pay for lobbyists have any voice in the system.

Since the lobbyists have but one allegiance, to the client that pays the fees, safeguarding our country is no longer central.

The World is Making Other Plans

From Reuters;

TOKYO (Reuters) - "The role of the U.S. dollar as the key global currency will decline after the financial crisis, and its value may also weaken due to America's current account deficit, officials at some of Asia's top think tanks said."

"Chalongphob Sussangkarn, a former Thai finance minister and now president of Thailand Development Research Institute, also expressed worries about any sharp fall in the dollar."

"The U.S. deficit is so huge. This is why all countries, particularly East Asia, are concerned because we hold a lot of these assets. What happens if the U.S. dollar falls 40 percent? Many central bankers will be losing huge amounts of money."

From "The Japan Times";

"The U.S. alone can no longer resolve the current global economic crisis."

"In order for the entire Asian region to keep growing, we must create the third-polar regime in Asia by introducing the Asian common currency, which stands on par with the US Dollar and the euro," the report says."

From FT.com;

"China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund."

“This is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money,” said Qu Hongbin, chief China economist for HSBC."

From the Straits Times;

"PARIS - IMF managing director Dominique Strauss-Kahn said on Wednesday that talks on a new world reserve currency to replace the US dollar were 'legitimate' and could take place 'in the coming months'."

From The Moscow Times;

"The Kremlin published its priorities Monday for an upcoming meeting of the G20, calling for the creation of a supranational reserve currency to be issued by international institutions as part of a reform of the global financial system."

Is it time to ask US citizens to "Get a Clue?"

The failure of Washington to rein in the abuses of our financial system will cause world leaders to seek remedies away from US interests. The continuing bailout of failed banks, the blind eye given to enforcement of existing law, and the elimination of protective law, has created a mountain of anger among world leaders.

Instead of listening to its people, the US government has committed an additional $8 Trillion to attempt to deal with the aftermath of "toxic" assets. Back last September, at a rate of 300:1, congressmen and congresswomen received faxes, phone calls and letters against the original EESA/TARP. Congress then voted, against their own constituents wishes, to grant Henry Paulson use of $700 Billion in taxpayer monies, at his own discretion, with no oversight.

Within weeks, the Federal Reserve committed the US taxpayer to a (illegal) buyout of AIG. Though Ben Bernanke, and Paulson, said the taxpayer would realize a profit from this venture, it has amounted to nothing but a $200 Billion loss. A great deal of that money has gone to companies which had already received TARP funds. It is reported that AIG still has over $2 Trillion in CDS contracts. Many anticipate that to be a 100% loss. Again, to be added to the national debt.

When the original TARP was not enough to keep otherwise insolvent banks from going under, the Federal Reserve began to negotiate directly with these banks. Citi now has guarantees for $300 Billion of "toxic" assets. Bank of America has guarantees of more than $100 Billion. Citi and Bank of America may very well have several times those "toxic" assets still outside of any regulatory view or control, that have yet to even be considered.

Now the government comes up with a plan to shift the losses of Trillions more in "toxic" assets to the taxpayers.

The banks, all of them, should be allowed to rise and fall on their own decisions. The creation of assets that are now toxic was the decision of a few. Those few should bear all of the consequences. Not the taxpayer. It is how a "Free Market" system is supposed to work.

Even though it has become obvious to the rest of the world, the average US citizen is oblivious. The reason congress acted as it did was for one reason: The US legislative process has devolved to nothing more than a system of lobbying. Only those with the money to pay for that lobbying have any voice in this system.

Nothing else explains why any congress person felt comfortable enough voting for the original TARP, when they heard from the people that elected them, at a rate of 300:1, against the TARP.

Funny thing is, two weeks later a national election occurred, and most of these congress folk were voted back into their seats.

Because more than 70% of all Treasuries issued sit in foreign accounts, the value of those Treasuries, and the dollar, sit in those accounts as well. At the rate the national debt is increasing, just to save banks that made bad decisions, many of these foreign holders of US debt are getting nervous. Initiatives to wean themselves from reliance on the US are being sown because of that nervousness.

Many foreign central banks feel the US has misled them. When most of the Treasuries they own were purchased, the US appeared to be a Free Market, and confidence in our system was high. Over the last 18 months, the actions of The Federal Reserve and US Treasury have quadrupled the amount we now owe. The majority of that increase has gone to otherwise insolvent banks to cover losses from toxic assets. Confidence in our ability to service the increasing debt goes down with every new Treasury sold. To a holder of US Treasuries, further commitments that may double the national debt from here, without creating new economic activity, will cause alarm.

Folks, this is very bad. Were it not for that initial confidence in our system, we would never have been able to sell that many Treasuries, and we would never have reached the current level of debt. Plans to increase our debt would never be started without that confidence. The world is politely telling us WE ARE LOSING THEIR CONFIDENCE. Pretty soon, the dialogue may not be so polite.

Unless our elected officials immediately start doing what is best for everyone, and not the privileged few, expect some drastic actions from those foreign holders of US debt.

BTW - Be like Yukon Cornelius and look for silver and gold.

Dollar Dominance and China

The actions in Asia, especially China, must be paid close attention to by the leaders in the US. China is integral to any of our stimulus and bailout plans, because someone must buy the Treasuries we issue to fund these efforts. Few others can help us as much as China.

China currently owns more US denominated debt than any other single entity, in the world. That allows the leaders in the US to think that the Chinese have as much reason as we do to maintain the value of those investments. Since the value of those investments will rise, or fall, on the strength of the US's ability to repay those loans, many here feel that all those that own Treasuries will help save the value of those Treasuries.

This line of thinking includes the presumption that all those that buy Treasuries will hold them to maturity, thus extending the time frame for actions that will prop up the value of those Treasuries. This thinking is also a natural extension of the US and its dollar as the reserve currency for the world. Many of the world's largest transactions, especially in certain commodities such as oil, are mainly conducted in dollars. It is hard for the leaders of the US to see the world differently, for they, as well as all Americans, have enjoyed the benefits of this position since WWII.

Every discussion of global trade, foreign policy initiatives, intervention in markets, you name it, is framed in the unstated understanding the US is the world's leading power and leading economic engine. For decades this underlying truth has been globally assumed for all dialogue and discussion, both public and private. While the world grapples with the growing economic crisis, it looks to the US for solutions. The US, because of our position in the world and the resources at our disposal, will remain at the top for the foreseeable future.

But, our leaders, and more importantly our media, should pay close attention to new ideas from other world leaders. Currently, there are powerful undercurrents to lessen not only the US's position in the world, but to diminish the US Dollar as the reserve currency for the world.

As I wrote a few weeks ago in "Chinese Economists Favor Gold Over US Bonds", more than two-thirds of Chinese Economists favor the central government invest in gold, rather than US Treasuries. That is very revealing, for most of these economists work either directly, or indirectly, for the Chinese government. What they favor must be assumed to be what the Chinese government favors. In comparison, the US is adopting the ideas put forth from its economists to solve the current economic crisis. Should we think the Chinese won't do the same?

If China does what the economists suggest, they won't be buying many US Treasuries in the future, they will use extra surpluses for purchases of gold. That may translate into a bad outcome in the near future sales of US Treasuries. In Britain, the funds needed for stimulus have already been denied. From "U.K. Bond Auction Fails for First Time since 2002";

"March 25 (Bloomberg) -- The U.K. failed to find enough buyers for 1.75 billion pounds ($2.55 billion) of bonds for the first time in almost seven years as debt investors repudiated Prime Minister Gordon Brown’s plan to stem the worst economic crisis in three decades."

"The risk of failed auctions is increasing as governments around the world boost spending to revive their economies after financial institutions incurred more than $1 trillion of losses and writedowns since the start of 2007."

Britain, prior to this failed auction, has said it will sell 146.6 Billion Pounds in debt in 2009 to try to revive its economy. The first 1.75 Billion failed to attract enough buyers. The likelihood they get to their goal of 146.6 Billion Pounds now seems remote. To repeat a line from the above article, "The risk of failed auctions is increasing....". The US has almost quadrupled its debt over the last decade. The reason Britain failed to sell even a small fraction of the bonds it needs for economic recovery is investors feel Britain already has more debt than they can service. How soon will investors feel the same concerning the US?

At this point, the Chinese economists seem to have more faith in gold, than US Treasuries.

There exists a second, and more compelling reason, the Chinese may not buy Treasuries in the near future. It is their desire to topple the US Dollar as the Reserve currency for the world. These same economists, and the central government, are slowly moving to a formal position that the volatility of the dollar, and value of US Treasuries, has them hostage. As long as they hold huge reserves of dollar denominated debt, the value of their investments is subject to the actions of the US government. Throughout Asia, the idea of reliance on the dollar, and safety of US Treasuries, is no longer guaranteed. Thus, it may not be in their best interests to be reliant on either.

The Chinese, as well as the Japanese and Koreans, bought many of the MBS from Wall Street, FNMA and FHLMC. They saw first hand the rapid decline in those investments, some as much as 50%. Convincing them future debt sold by the US will not have the same outcome has now become much harder.

China is now leading the charge to replace the Dollar with the Yuan as the reserve currency for all of Asia. From Jim Willie writing in "Financial Sense";

"A crisis of global confidence in the USDollar is upon us. Foreigners have begun to lose respect for USGovt approach to problem solving, for US bank administration, and for USDollar custodial management. Foreigner creditors have suffered deep losses from fraudulent bond export, continue to sit atop mountains of US$-based debt securities, and watch current events in horror."

"Due to USDollar instability and unreliability, Beijing is introducing a serious currency experiment, in order to aid in the stability of the Asian economy. The Chinese intention seems clearly to decouple both China and Asia from the USDollar and to introduce the yuan as the regional reserve currency."

"This is a very clever economic as well as political plan by China. The plan is a pathway for regional economic stability for Asia, centered finally in China in a monetary sense. China will proceed under the legitimate political cover of their own financial reform toward stabilization. Chinese bank leaders like Zhou Xiaochuan have begun to state publicly some nontrivial arguments about how continuation of the current US$-based global unipolar financial system bears costs and risks that far exceed the benefits........The Chinese are considering a new debt security, which will compete for Asian surplus funds and thus displace the USTreasury Bond. If successful, the Chinese will turn the tables completely, and wear the big currency boot. Chinese sentiment has changed, as has their patience."

Should the US not find a solution soon to the economic crisis, which is radically different from what is currently proposed, expect other nations to proceed on their own. China, as well as many other countries, blame the US for this mess. Since the US has refused to jail those responsible, and, over the last 18 months helped those responsible hide the carnage, China, as well as Russia, Germany, France and Saudi Arabia, have all been very vocal about reducing the US's role in world markets.

This is very bad for the US. Under the current plans, the US must sell several Trillion in US Treasuries over the next two to three years. Since those Treasuries have no physical asset backing them, such as gold, any actions like those described above, will reduce any interest in buyers. At the same time, if China creates its own set of bonds, and auctions them, most Asian countries will purchase those instead of US Treasuries.

For many reasons, the world has changed dramatically over the last decade. Most countries can diminish their anger over the Iraq War. In contrast, they are now willing to take action against the ravages of Wall Street's creative financing.

The US forced the moral argument over the last 50 years to focus on money and wealth. It is that focus that may end our current system as we know it.

When on the Government dole.......

This is too good not to talk about.

There are literally hundreds of thousands of homeowners "underwater", meaning they owe more than their home's appraisal value, with their mortgages. First the Bush administration, and now the Obama administration, have gone to great lengths to warn homeowners not to pay a fee for an attorney to help you negotiate for a loan modification. If done properly, a loan modification can reduce interest payment, reduce the principal owed, or both. It is especially helpful if you happen to have taken an Option ARM loan, which can carry severe increases in payments beyond the "teaser" period.

The last thing a bank or servicer wants to do is lessen the amount you pay. Every nickel matters to a bank, more so if you are with one that placed an additional bet on the performance of your mortgage by creating a CDO, CMO or similar credit derivative which they have kept on their books. Those losses are magnified.

If you are paying your mortgage on time, no matter where you live, or what type of mortgage you have, the bank will NEVER let you modify. Your loan is performing, and they have no incentive to reduce what you are paying them. Both neighbors directly on either side of you may have already gotten a loan mod, or worse, walked away from the house, and the bank still has no incentive to help you reduce your payments. Many who read this will agree with the bank. The borrower has a contractual obligation to fulfill the terms of their mortgage. It is hard to say these people are wrong, because deep down, we all know the law is the law.

But then don't tell me you are angry about AIG executives, who wrote the derivatives that are sending all of us into a depression, shouldn't get their bonuses. Henry Paulson and the Bush White House wrote the contract with AIG. Yes, Geithner knew of it back in October, when it was written. But, the contract had already been signed. Long before Obama was even elected.

What the government is doing now, advertising to the public to avoid loan modification companies that charge a fee, while they are giving massive amounts of money to these banks to keep the derivatives hidden, is criminal.

None of these loans that are now blowing up should ever have been given, none of them. What was so wrong about a thirty year mortgage with 20% down and a Debt to Income ratio of 35% or less? That is prudent lending.

105% financing with 50% Debt to Income ratio is something a fool does. If a bank wants to give you money under "the deal of a lifetime", and tells you it is okay, isn't it the bank's duty to know right from wrong when lending their depositor's money.

What does it say about that bank when they knowingly sell that risk to someone else?

What character flaws have to be present for a company to buy tens of thousands of these loans, package them into MBS, and then create a CDO, which they then sell to a pension fund or a money market account for huge fees, knowing there is great risk of default?

The Federal Reserve, and now the government itself, not only are cognizant of these underlying causes for the meltdown, they are extending them. While they tell the public that you should not let an attorney help you modify your loan, they are giving the banks Trillions of dollars. What the government does not tell you is most Loan Modification companies charge $2500 - $4000, depending on the amount of your mortgage. The average savings to homeowners, over the life of their loan, can exceed $100,000 on the average house. That seems like a deal to me.

Maybe it's because the government has had its own modification plan for over 5 months. It is called "Hope for Homeowners." It was touted by the previous administration as the financial panacea for over 400,000 families. $300 Billion has been allocated by congress to go to this program.

And what a rousing success it has been. In 5 months, there have been 752 applications. It has helped prevent 1 (one) foreclosure. Maybe the other 751 applicants decided it was better to use a loan modification company and have an attorney argue with the bank.

The reason for the failure of Hope for Homeowners- The banks are to voluntarily refinance delinquent mortgages by reducing the principal balance on loans to 90% of a home's current market value. In states like California, Florida, Arizona and Nevada, the decline in housing values exceeds 50% in some neighborhoods from the peak.

As long as the Federal Reserve, Congress and the Government give banks free money to keep them alive, and pay million dollar bonuses, they essentially are saying "screw the average American."

Why should Ken Lewis voluntarily do anything? After all, he is only interested in keeping his stockholders happy, and his compensation package whole. The rest, well, Bank of America is too big to fail, right? So, let the taxpayers pay for his losses.

Folks, until the banks that need taxpayer money to stay open, due to their own stupidity and lack of character, are forced into doing anything differently, they won't.

Here's how you force them. Every financial institution that must have government money to stay open, must immediately go to the Government's own pay scale. Everyone in the financial institution immediately goes to the new pay scale, at their equivalent government grade, for as long as they need the government money. They can resume their old pay structures when they get out of the hole, pay the government back, and be a self sustaining business.

If they don't accept those terms, they can choose to go it alone.

We would find out very quickly who the Good Americans are, and those that just wrap themselves in the flag for their own benefit.

Why should Ken Lewis get paid more than a General in Afghanistan? It is that General who makes Ken's life possible. If Ken screwed up, why should anyone else have to pay for it?

And the average homeowner should be able to level the field and negotiate with Ken with the aid of an attorney.

Just food for thought.

More Mark to Market

From the Opinion page at the Wall Street Journal (I just wish they had started talking about this two years ago, the problem would be a fraction of what it is now.)

We Need Honest Accounting
Relax regulatory capital rules if need be, but don't let banks hide the truth.
By James S. Chanos

"Mark-to-market (MTM) accounting is under fierce attack by bank CEOs and others who are pressing Congress to suspend, if not repeal, the rules they blame for the current financial crisis.'

"We have a sorry history of the banking industry driving statutory and regulatory changes. Now banks want accounting fixes to mask their recklessness. Meanwhile, there has been no acknowledgment of culpability in what top management in these financial institutions did -- despite warnings -- to help bring about the crisis. Theirs is a record of lax risk management, flawed models, reckless lending, and excessively leveraged investment strategies. In the worst instances, they acted with moral indifference, knowing that what they were doing was flawed, but still willing to pocket the fees and accompanying bonuses.'

"Financial institutions had no problem in using MTM to benefit from the drop in prices of their own notes and bonds, since the rule also applies to liabilities. And when the value of the securitized loans they held was soaring, they eagerly embraced MTM. Once committed to that accounting discipline, though, they were obligated to continue doing so for the duration of their holding of securities they've marked to market. And one wonders if they are as equally willing to forego MTM for valuing the same illiquid securities in client accounts for margin loans as they are for their proprietary trading accounts?'

"According to J.P. Morgan, approximately $450 billion of collateralized debt obligations (CDOs) of asset-backed securities were issued from late 2005 to mid-2007. Of that amount, roughly $305 billion is now in a formal state of default and $102 billion of this amount has already been liquidated. The latest monthly mortgage reports from investment banks are equally sobering. It is no surprise, then, that the largest underwriters of mortgages and CDOs have been decimated.'

"There is a connection between efforts over the past 12 years to reduce regulatory oversight, weaken capital requirements, and silence the financial detectives who uncovered such scandals as Lehman and Enron. The assault against MTM is just the latest chapter.'

"........The truth is the market is functioning correctly. It's just that MTM critics don't like the prices that investors are willing to pay.'

"Unfortunately, the FASB proposal on March 16 represents capitulation. It calls for "significant judgment" by banks in determining if a market or an asset is "inactive" and if a transaction is "distressed." This would give banks more discretion to throw out "quotes" and use valuation alternatives, including cash-flow estimates, to determine value in illiquid markets. In other words, it allows banks to substitute their own wishful-thinking judgments of value for market prices.'

"Obfuscating sound accounting rules by gutting MTM rules will only further reduce investors' trust in the financial statements of all companies, causing private capital -- desperately needed in securities markets -- to become even scarcer. Worse, obfuscation will further erode confidence in the American economy, with dire consequences for the very financial institutions who are calling for MTM changes."

For more reading on Mark to Market;
Bloomberg
The Big Picture
Goldseek
Economy in Crisis
Nicole Gelinas
Market Ticker

Easy Picken's

After reading, hearing and watching all the furor over the new TALF, the feeling is not as bright as yesterdays' upswing in the market. The only people for the new program are the very same people who told us:

1) The original market interventions by the Fed, including the TARP, were necessary and would work. So far, the Fed has increased its balance sheet almost $2 Trillion, mostly by exchanging good US Treasury Bonds with toxic assets from the banks.
2) The Maiden Lane operations (I, II, and III) initiated to cover losses of CDO's by Bear Stearns, then AIG, were promised, as late as January of this year by Ben Bernanke, to give taxpayers a profit. Maiden Lane has so far lost over $40 Billion, and counting.
3) The bailout of Fannie Mae and Freddie Mac were supposed to increase mortgage lending. So far, the only result is a loss of $100 Billion to each.
4) The bailout of AIG directly would give the taxpayers a profit ($200 Billion loss, so far). To date, it has amounted to a pass through so companies already receiving bailout monies could get more. Now, many sources are reporting the losses could go as high as a few Trillion.
5) $25 Billion to the US automakers was, we were told, to allow them to retool and start making cars of the future. No cars of the future yet, but now they are getting $17 Billion more, with proposals to extend that to maybe $60 Billion.
6) $300 Billion in guarantees of "toxic" assets for CitiGroup would calm the markets. In exchange, the government received warrants for shares in Citi, that they value at $20 per share. Citi currently trades at $3 and change.
7) A sustained ZIRP (Zero Interest Rate Policy), or almost ZIRP, from the Fed was supposed to ease lending to bring housing prices back up. Since lowering rates, housing values have fallen further and faster.
8) Ben Bernanke has predicted several times over the past two years that his initiatives would cause an upturn in GDP in a few quarters. He now predicts the GDP will rise in the second half of this year. More than 2 million jobs have been lost since his first prediction.

The new TALF, if not policed, will only provide a backdoor for the banks that are most bankrupt to dump their toxic, level 3 assets on the taxpayers.

The proposal requires 5% from the private investor, and the government will loan them another 5% to meet a 10% down down payment. Let's say Citi has an SIV that they claim is worth 80% of its original $1 Billion value. No private investor will pay 25% for this SIV. Now, through an intermediary, Citi is able to put in a bid for the 80%. They pay $40 Million, the government pays $40 Million. That covers the 10% down payment. Now that SIV is off of Citi's books, and onto the FDIC's, Treasury's or Fed's books.

If it loses all of its value (which in the case of SIV's is highly likely), Citi (or its intermediary), instead of being out $800,000 million more, is now only out $40 Million. They effectively just transferred the remainder of the loss to the taxpayers via the Fed, Treasury and FDIC. Any amount they are able to get on the open market, should a cash flow actually be sustainable from the SIV, will lessen the loss. The point is, they currently cannot sell it for anywhere near what they have in it. Too many of the people that predicted the crisis was contained two years ago, are the same people now saying the SIV is worth what Citi says it's worth.

For more on this, please see;
Karl Denninger
Mish
Reuters: Stiglitz

I can only hope and pray there are safeguards to keep what I described from happening. The idea that they are hiring hedge funds as subcontractors to conduct all of this does not bode well, for me.

For a very good read, may I suggest Matt Taibbi's article "The Big Takeover" in Rolling Stone.

The Winds are Blowing Harder

It seems the winds are blowing harder.

With the Fed's Quantative Easing, all the current bailout extensions with the promise of Trillions more, and now the imminent unveiling of Geithners new TALF plan, which will create the "bad bank" scenario (under the FDIC?!), the amount of US Treasuries being printed will soon skyrocket.

Well, we won't be alone. The EU will soon be forced to consider the same. Although, the EU is not the US, and an unraveling there is very likely. It will only take one or two prominent members to back away from such proposals, or another unexpected series of bank failures, to insure the EU will not be able to fully implement an identical plan.

Funny thing is this, the US and the EU will need for each other to buy the new bonds for either plan to work. China will not be participating at a meaningful level, they are worried about the future value of what they already have. The Indians have notoriously avoided overexposure to US and EU debt for years, and there is no indication they wish to swim in that pool now.

That leaves the handful of smaller states and unions for the Treasury to go begging too. The oil rich states won't buy many, unless oil goes back up to $100+ bbl. Japan, they just started there own bailouts, again. Korea just got us to buy back Agency bonds that had lost 50+% in value in a couple of years, so it is unlikely they buy Treasuries that have a good chance of losing some value. Brazil is busy forging new relationships with everyone except the US. Singapore? They seem to be waiting for the fallout to begin bargain hunting, plus, they are investing in food production at an increasing rate.

Who else, that can buy $5, $6, $7 Trillion or more of US Treasuries over the next few years?

Remember, China is the largest holder of US Treasuries at a little over $1 Trillion. And it took them years to get to that point. China was only able to do that because of the enormous trade surplus created by a mountain of credit in the US. China ramped up its production, and sold all of those goods, to Americans who were borrowing against the rising value in their houses.

The rise in credit, and borrowing, in the US was so great that from 1990-2007, China increased its manufacturing of goods 673%. In comparison, the US increased its manufacturing 76% during the same period.

Because our leaders are convinced we must save the companies most responsible for our current situation, they are following the same path these very companies took in getting us here. That is, the US is committed to overleveraging to try and ease the effects of overleveraging.

Paco Ahlgren, writing for Seeking Alpha, sums it up nicely;

"The U.S. government, however, wants you to believe that the only cure to this disease, brought on by decades of inflationary money-printing and easy credit – which inevitably led to malinvestment, unprecedented economic volatility, and ultimately, several horrific economic collapses – is yet again to expand the money supply and to further ease credit until the U.S. consumer resumes his relentless and irresponsible plight to spend, rather than to save. I'm at a loss as to how anyone of a sound and rational mind can honestly believe that the solution to this type of economic catastrophe is yet more borrowing and spending. It's like saying the cure for heroin addiction is an overdose. It's preposterous."

It seems painfully obvious to me this is hardly a solution. To double down on a bet, when your cards are a 2 and a 4, and the dealer is showing a 10, almost always leads to a loss of the bet.

All we can do at this point is pray the economy does not regurgitate another 2 million jobs over the next 4 months, and the government, paying 80 cents on the dollar for "toxic" assets under the new TALF, is able to recoup that 80 cents. Highly unlikely, because the government is hiring a few select hedge funds to run the program.

Most people follow the government numbers when it comes to unemployment figures. Those numbers, what the BLS (Bureau of Labor Statistics) uses, have been changed several times over the last 50 years. If we were to use the system they used in 1932 to calculate unemployment, the rate of unemployed would be over 15%. Not 8.1%

How many jobs would investment in "green" technologies, rebuilding infrastructure, and revamping our factories to produce more of our own goods would $12 Trillion buy? That is the amount committed, today, to save the existing credit system.

That $12 Trillion may be lost in entirety if the value of the Treasuries being issued falls. The government is assuming it can ease the flow of credit, which will somehow translate into borrowing, that will create new jobs. Even if it works, and that is one big if, that process will take decades when you factor in the current losses that must be accounted for first.

Somehow, we must start creating as many jobs as are being lost. With all of the resources going to propping up "zombie" banks, I find it hard to understand how we are doing that.

Is this what we really want?

First the Bush administration, and now the Obama administration, are allowing their buddies on Wall Street to keep the insane amounts of money they have made over the last eight years, and forcing you, the average citizen, to pay for their yachts, mansions, first row seats, etc. Even the Politburo would have denied this.

To add insult to injury, our leaders now say the contractual obligations of the bailout structure demand these companies, that MUST have taxpayer money to keep from going bankrupt, give bonuses for losing money. Bonuses, by the way, to the very individuals that caused the ramp up in over-leveraging by selling fraudulent bonds, that are now worthless. Several hundreds of trillions of dollars of worthless.

For all those blaming Obama, Geithner may have been part of the original negotiation with AIG. But he worked for Bernanke. Henry Paulson and the Bush White House were the ones that drew the original contract. Goldman Sachs has been a major beneficiary of the money given AIG.

Do you honestly believe that is a coincidence?

Under which President did the bailout party begin?

Ok, on to the next worrisome tidbit. It is fraud if an insurance company writes a $100,000 policy on a house, yet only has $5000 in assets. Should something happen to that house, and they have to pay $100,000, it is clear they do not have the assets to cover it.

It is also fraud to represent a security as safe, when it is clearly not. If an investor buys a loan to make money on the interest, and is told it is from someone with the best credit score who had enough income to pay the maximum payment, he expects that to be true. If it turns out that someone only made enough money to pay half the maximum payment, and their credit score was 100 points less than what is considered good, that is fraud.

Both of these things are at the heart of our current crisis. Loans that were represented as having sound underwriting have been proven anything but. Credit Default Swaps were, and still are, being sold by companies that do not have the capital to pay off when the credit derivative they have been issued to insure, defaults.

The latter is exactly why AIG is now owned by the government.

Both of these constitute fraud. Yet, we had President Obama tell Jay Leno that there was nothing illegal about the build up to our current crisis.

I don't know about you, but for me, that is probably the most unsettling statement I have heard from a President in years. And we just got past a President that made a lot of unsettling statements.

It means there may be no investigation into all the blatant fraud coming from Wall Street over the last eight years. Goldman Sachs, among others, were selling CDO's and CMO's, with fraudulent underwriting standards, then immediately buying CDS from AIG, betting those CDO's and CMO's would fail.

AIG still has over $2 Trillion in CDS floating around out there. The $200 Billion so far to AIG is only a drop in the bucket. Remember when Bernanke and Paulson told us the taxpayer might make money on AIG? If these guys are the smartest financial guys we have.........(reference above picture).

Watch what the Chinese, and maybe many other countries, do next. They expect some very big people on Wall Street, and I am not referring to Bernie Madoff, to go to jail over all of this. If we do not send them, the rest of the world will let us choke on our own vomit. Guaranteed.

You see, it is not only US corporations that have been affected by the credit meltdown. We have exported these "toxic" assets to every corner of the world. Large foreign banks have them. The Central Banks of major trading partners have them. Sovereign Wealth Funds have them. Pension accounts and money market accounts around the world have them.

They all expect the US to do what they consider the right thing, and jail those responsible for selling them something that was not what they were told. And if we don't do that, they expect the US to make them whole on all losses.

Well, when the losses amount to hundreds of trillions of dollars, we just don't have the ability to raise that kind of money. You have heard a very few congress people say it is far worse than you know, this is what they are referring to.

Many are upset that the previous administration is not being pursued for crimes against the constitution. Because the economic crisis is an immediate threat to the foundation of civilization, it must be dealt with first. Giving a pass to financial crimes, when the losses are greater than available monies, is a huge mistake. The US must stand up and tell the world that fraud will not be rewarded.

Bonuses to AIG tells the world that fraud is rewarded. At least in the United States of Goldman Sachs.

AIG Sues Countrywide

Thanks to Justin Owings @ ML-Implode for the graphic

It was only a matter of time before this train started selling tickets.

AIG Sues Countrywide for Misrepresenting Mortgages

Countrywide, under the stellar direction of Angelo Mozilo and David Sambol, began to lower their guidelines for "prime" loans sometime in 2004. Countrywide, then the largest mortgage lender in the nation, decided to up their profits by allowing people with low credit scores, putting little or no money down, into loans designed for people with good credit scores.

"United Guaranty said in the complaint that it had reviewed loan files that showed that most mortgages covered by 11 policies for asset-backed securities were either underwritten in violation of Countrywide’s own guidelines or contained defects, such as missing documents, misrepresented credit scores or false social security numbers."

The problem is well beyond AIG. All of these loans, and there are a few trillion dollars worth of them, are scattered around the world in MBS, CDO's and other credit derivatives. That means the fallout is only beginning. FNMA and FHLMC alone hold about $1.5 Trillion in these loans from Countrywide on their books. The default rates from the Countrywide originations are far greater than any other group, including subprime.

What AIG is accusing them of is selling loans as prime that were actually subprime or worse. Because the borrowers were able to get terms reserved for those that have the best credit scores, it means those terms can lead to financial difficulty sooner for someone with less financial resources.

Of course these loans would blow up sooner and at a greater rate.

Countrywide didn't care. They were making huge profits, and Wall Street loved them for the constant supply of loans they could securitize and turn into derivatives.

I have been talking about this problem for years. In 2005, I received a nasty letter from the Countrywide legal team telling me to stop representing Countrywide's guidelines and accounting procedures as "unethical." Well, I have never stopped, and have been asked twice to present, in court proceedings, against Countrywide on behalf of plaintiffs. Both cases were settled, out of court, of course, in favor of the plaintiffs.

Countrywide has gone through great efforts to conceal its behavior. Many people like me were intimidated into silence. As were many former employees. Countrywide's customer service is abysmal, their double billing and lost payment records legendary. There will be many more stories on this subject, and I expect the number of companies suing Countrywide, now Bank of America, to increase.

My big question is this - If Fannie and Freddie together have $5 Trillion in loans, and $1.5 Trillion are from Countrywide with false underwriting standards, what will the end result for them be?

Domestic Terrorists are Everywhere

No really, according to the Missouri State Police.

From Chuck Baldwin Live via Nabble;

"Thanks to a concerned Missouri state policeman, a nationally syndicated radio talk show host stated that he was alerted last week to a secret Missouri state police report that categorized supporters of Congressman Ron Paul, Bob Barr, and myself as "'militia' influenced terrorists." The report, he said, "instructs the Missouri police to be on the lookout for supporters displaying bumper stickers and other paraphernalia associated with the Constitutional, Campaign for Liberty, and Libertarian parties."

I really like the fact Ron Paul is the only congressman not VUI (Voting Under the Influence) from lobbyists money. At least someone is willing to say "Hey, Bernanke, you promised 18 months ago the subprime crisis was contained, what happened?"

One must keep in mind that Missouri also leads the nation in methamphetamine labs. When you get a bunch of drug crazed, pseudophedrine smoking loonies running around, you also get Ron Paul supporters.

I should really take offense to this. A few years ago, I had the privilege of talking with Bob Barr, one on one, for a few hours. My wife and I had just listened to him give a fabulous speech on why the Patriot Act should not be renewed. Luckily, I cornered him for one quick question, and he asked us to join him for awhile. Bob Barr is a good American, and anyone that tells me otherwise probably isn't.

Yes, the police should be on the lookout for those so mad at the system that violence may ensue. The Oklahoma City bombing is proof enough of that. But Ron Paul supporters? C'mon.

Things are getting so nuts in this world that I heard, in disbelief, a former Bush White House legal aide actually say the Oklahoma City bombing was the work of Saddam Hussein, and that was why we needed to invade Iraq. No kidding, it was on "Hardball" with Chris Matthews.

Talk about domestic terrorists - these Bush supporters will say anything. No matter how schizophrenic it is. Maybe that's the problem, schizophrenia may have been a prerequisite to work in the Bush White House. They are the ones that made the contract with AIG, where bonuses would be paid for losing money.

Before I get myself into too much trouble, a few more excerpts;

"According to the MIAC, opposition to world government, NAFTA, federalization of the states, and restrictive gun laws are a potential threat to the police. The MIAC report also refers to Aaron Russo's film, "America: Freedom to Fascism."

"The story exposing the MIAC report states, "The MIAC report is particularly pernicious because it indoctrinates Missouri law enforcement in the belief that people who oppose confiscatory taxation, believe in the well-documented existence of a New World Order and world government (a Google search of this phrase will pull up numerous references made by scores of establishment political leaders), and are opposed to the obvious expansion of the federal government at the expense of the states as violent extremists who are gunning for the police. It specifically targets supporters of mainstream political candidates and encourages police officers to consider them dangerous terrorists."

I can assure one and all, I have always viewed the police as friendly. If you have ever been the victim of a crime, especially one when a gun was aimed at you, you learn quickly the police are there to "Protect and Serve." The police shot the bastard that was not only pointing a .357 at me, he was bouncing it off my nose (I still have the scars to this day.) I will always have Officer Louis Mattea to thank for getting him.

From InfoWars;

"The MIAC report does not concentrate on Muslim terrorists, but rather on the so-called “militia movement” and conflates it with supporters of Ron Paul, Chuck Baldwin, Bob Barr, the so-called patriot movement and other political activist organizations opposed to the North American Union and the New World Order. The MIAC document is a classic guilt by association effort designed to demonize legitimate political activity that stands in opposition to the New World Order and its newly enshrined front man, Barack Obama."

I am not sure I agree that Obama is the frontman for a New World Order. He just happened to win an election at the worst possible time, and did not have smart enough advisers who could see that 15 years of deregulation and unenforcement of laws allowed Wall Street to kill our financial community. I have been telling my wife for 5 years that the Democrats should lose every election, just so the Republicans could wallow in the mire they created. But, the Democrats, if nothing else, are inept. The Republicans probably could see what was coming, it's why they nominated McCain, hoping he'd forget a few lines during the debates. To ice the losing cake, they somehow got Palin to be his running mate. Game, set, match.

Alas, even if McCain would have won, the Republicans still would have blamed it on Clinton.

Mark to Market, Mark to Fantasy

The idea that mark to market is widely used still persists.

Mark to fantasy is the current model for all things considered "toxic."

For tens of trillions of bonds, stocks and other securities, mark to market does exist, and rightfully so. In a true Free Market, no asset should be claimed to have more value than what the highest bidder is willing to pay for it. All prices for stocks, bonds, commercial paper and any other investment vehicles should have a clear bid/ask system, so that anyone, at anytime, can place a true value on on any asset to determine value.

For hundreds of trillions of bonds and other securities, there is no mark to market. Off shore shell corporations and level 3 accounting allow accounting books to claim virtually any value on a security because there exists no clear bid/ask system for these assets. There are still many credit derivatives that have little or no value that are in level 3 accounting with a claim for the full purchase price as the current value.

The reason they are called derivatives is they "derive" their value from something else. In the case of a CDO, it "derives" its value from the performance of several Mortgage Backed Securities, which themselves own maybe thousands of mortgages.

A home loan in most cases, is only serviced by the bank. Some other entity either put up the money for purchase (FNMA, FHLMC, GNMA) or the bank used its own money, for a short period lasting usually a few weeks, then sold the loan to someone else. That someone else then packages that loan, with hundreds of others, into an MBS. The bank is paid a small fee for servicing (acting as the bookkeeper) the loan through maturity. When a mortgage defaults, the bank servicing that loan must rectify the difference between what is owed on the mortgage, and what they receive through short-sale or foreclosure.That difference is a loss in principle to the MBS, and is also a loss in revenue from the lost interest. The MBS realizes a loss, but only for the difference between what was borrowed and what was received in foreclosure, plus the interest lost.

The CDO receives nothing from a short-sale or foreclosure.

Since the CDO, which is a credit derivative, is a bet on the positive performance of the MBS and has no claim of ownership of the MBS or the mortgages in it, the loss in the tranche which holds that defaulted mortgage is 100%. The CDO is a contract whose model was, more often than not, based on that mortgage actually paying off early, which meant more fees due to prepayment penalties in mortgage contracts. Since fewer houses are being paid off early, and many more are in foreclosure, the losses within these CDO's are massive. Every loan modification reduces the value of that mortgage in a MBS, yet it is a 100% loss in the tranche of the CDO.

Almost all of these credit derivatives are being held by large corporations in level 3 accounting.

From Tracy Alloway writing for ft.com;

Mark-to-market has been around for years but the FASB’s Statement 157 the current scapegoat for banking woes, was introduced in November 2007. The rule changed the definition of fair value and required financial institutions to identify how they determine that value, by creating a three-tiered hierarchy for classifying their assets:

• Level 1 - Financial assets and liabilities whose values are based on unadjusted, quoted prices for identical assets or liabilities in an active market.
• Level 2 - Financial assets and liabilities whose values are based on quoted prices in inactive markets, or whose values are based on models - but the inputs to those models are observable either directly or indirectly for substantially the full term of the asset or liability.
• Level 3 - Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.

As Alloway explains, the adjustments for this accounting hierarchy occurred in 2007, just after the collapse of these toxic assets began. Before 2005, the amount any financial institution was allowed to leverage was a maximum 14:1. In 2005, Henry Paulson went before congress, explained the economy would begin to suffer and jobs would be lost, if more credit was not allowed to enter the system. Congress then lifted the rule of 14:1, and allowed Wall Street and the banks to leverage with no limit.

Every single bank and broker that has gone out of business since 2005 had leverage ratios of 30:1 or greater. So much for deregulation and allowing Wall Street to police itself.

Level 3 assets are known in the financial world not as being marked to market, but being marked to fantasy. Marked to fantasy because the losses in a tranche of a CDO, CMO, CLO or the like can never be recovered. Once a default in the underlying security is realized, it is a 100% loss for the derivative. And now, these level 3 accounts are growing due to CDS, which is supposedly insurance against losses of credit derivatives. Funny thing is, many of the companies writing the CDS do not have the funds to pay off against losses in credit derivatives, yet are still writing them. The companies accepting them then claim all of their credit derivatives are good at full value, even though they know they will never get paid on a CDS, unless the government steps in.

This is exactly what is happening with AIG. They wrote hundreds of billions in CDS they could never pay off on. If the largest insurer in the world can't pay off on them, who can? Well, thanks to Paulson, Bernanke and Bush, the American taxpayer is paying off the CDS of AIG. Wall Street believes the taxpayers should pay for their profits, no matter how fraudulent the asset is.

As Karl Denninger in Market Ticker writes;

"Congress and prosecutors across the board, both State and Federal, need to start bringing indictments, starting with the fraudulent accounting.'

"You can't value something at "par" when you are well-aware that the underlying credit quality has gone straight in the toilet and that there is not a snowball's chance in hell that the "insurance" you bought to protect yourself has no chance of being "money good." As soon as you become aware of the impairment under the law you are required to reserve against it!'

"Everyone in the marketplace today now has proof that these swaps in aggregate are worthless, with proof of this found in the fact that The Fed claimed under oath exactly that as justification for the Bear Stearns bailout!'

"So you have a situation here where the entire banking regulatory system has declared these contracts worthless in the aggregate and yet company after company continues to claim in their financial statements and results that these contracts are "money good"!'

"This is out and out fraud and must be stopped."

The banks and brokers and hedge funds that own these credit derivatives know if mark to market were to truly begin, they would be bankrupt immediately, some several times over. This is why they are making a charge against mark to market, in hopes of keeping the FASB from removing the three-tiered hierarchy allowing level 3, which they plan to do this coming November.

If there are no observable inputs, ie a clear bid/ask system, then the asset can be put in level 3. If it is in level 3, there cannot be a fair market value measurement. Because the debt derivatives have no chance to recover the losses represented by defaults of mortgages they bet would be paid off, should these corporations be allowed to claim full value? Should they be allowed to claim, on national television, that their credit derivatives might someday gain back that value, when it is clear they cannot?

Do you believe it is a coincidence that there is no clear bid/ask system for these credit derivatives?

In our current system, the Free Market is no more. We have the Federal Reserve and Treasury injecting money into a select, small group of companies, that without the aid from the government, would be bankrupt. There is no mark to market for level 3 assets. And now we have corporate CEO's, CNBC, Fox Business and many other media helping to create fears that mark to market isn't fair. These are the same people who over the last 15 years claimed removing regulation and oversight of Wall Street would strengthen our economy.

These same people now say that government money must help the big banks, so the Federal Reserve has increased the money supply by $2 Trillion, and has almost $2 Trillion in toxic assets now on its books. The mechanism for accomplishing this is through printing more US Treasury bonds. Smarter people than I now believe we are creating a bubble with US Treasury notes. With $2 Trillion already diluting the US Bond market, and another $10-20 Trillion committed, or soon to be, all going to a select few companies that would otherwise be bankrupt, the bubble may burst sooner than most think.

China and the EU may start selling their Treasuries while the dollar still has high value versus other currencies. No investor uses their money to lose money. To limit their losses, any investor will sell what is losing value. Should the value of the dollar start to drop, massive sell off of Treasuries will probably happen.

It is rather ironic that the biggest voices for "Free Market Capitalism" are now endorsing corporate socialism, but only for a few. It is also ironic these same people championed deregulation, the lifting of leverage limits and creation of level 3. In retrospect, all three of these ideas have been a catastrophe for our economy. Their support for government intervention via increasing the money supply is looking to be another tremendous mistake.

To put this in perspective - Global GDP for 2007, that means all commerce counting everything that was bought and sold, was around $52 Trillion. The global amount of credit derivatives still sitting in off-shore accounts and level 3 accounting may exceed $500 Trillion. So... the amount of debt, that may have more than a 50% loss at today's valuation, with little to no chance of recovery, is ten times global GDP.

I don't know about you, but I believe it is beyond time to be worried. If we don't get the true value of all credit derivatives out in the open, today, the losses will only grow with every mortgage, commercial loan, credit card, student loan and boat loan that defaults. The problem began with credit derivatives having too much value placed on them. How can placing too much value now on credit derivatives be the solution?

Consumption Borrowing and Distortion

Most economic theories I have read posit there are 2 forms of borrowing, productivity borrowing and consumption borrowing. Farmers, manufacturers and most business loans fall into productivity borrowing. All consumer lending falls into consumption borrowing.

I would like to reformulate that into 3 categories of borrowing, 1) necessity lending - farmers borrowing to increase yield 2) productivity lending - manufacturer borrowing to increase goods and 3) consumption borrowing - to buy what you currently cannot afford. Waves of economic activity are mainly guided by productivity borrowing and consumption borrowing. Necessity borrowing typically occurs for supply to meet demand, except in times of natural disaster, and is less affected by the extremes of the other two.

The first category is almost always a "good" type of financing. What I mean is when the farmer borrows to increase corn, milk or pork output, it brings more to market. If there was a shortage of what the farmer is producing, more can now get what he increased. If the increase causes more supply than demand, prices fall. That is good for the consumer. If the farmer has "over reached" and produced too much, it will cause prices to fall below what he needs to repay the loan. The farmer will enjoy the reward, as will his consumers, if he borrowed correctly. The farmer will suffer the consequences, almost entirely alone, with little collateral damage to the broader economy, if he borrowed incorrectly.

The manufacturer is almost the same, except his reach into the broader economy adds a little more risk if he fails, yet more reward if he succeeds. With productivity lending, the manufacturer borrows to make more, let's say, lighting fixtures, which may also increase employment. His business is reliant on several factors going his way, such as an increase in refurbishing old buildings or in new buildings needing those fixtures. When the increase is consistent with his output, then the manufacturer succeeds, as does the broader economy through the increase in jobs and tax revenues. Should the increase turn into a decrease, then he must adjust his output, which effects the number of employees. When layoffs occur, several things happen. Tax revenues drop, so the local municipality has less for upkeep and improvements. Those salaries being spent into the local economy disappear, hurting restaurants, hardware stores, clothing retailers etc, The pain might even be deeper with the service businesses, they may have expanded during the time the manufacturer expanded, causing them to also cut back on staff, supply purchases, etc when the manufacturer cuts back. So, for society at large, there is a little more risk/reward to the broader economy through manufacturer borrowing.

The third category of lending, consumption borrowing, is very tricky to get right for any economy. Very seldom will lending to consumers have any effect on necessity lending. There are only so many hamburgers one can eat, and only so many glasses of milk one can drink. Very often, lending to consumers does have an effect on productivity lending to manufacturers. Consumption borrowing almost always occurs to enable the borrower to buy something they cannot immediately afford. Consumption borrowing almost always has no impact on necessity lending, yet almost always has impact on productivity lending. Only through consumption borrowing will the manufacturer realize increased sales beyond the "need capacity" of consumers. You need a car to get to your place of employment, and in the bank you have $10,000 which would buy a new Hyundai. But, because you want something more impressive, you borrow to buy the $35,000 Ford Explorer. You have just borrowed beyond your "need capacity." With that borrowing, the final cost is far greater than the $25,000 you borrowed (assuming you used your $10,000 as down payment.) Interest from the loan, higher insurance, less gas mileage, higher maintenance, and many other things may add an additional $15,000 over the next three years. So, your need was for a $10,000 car, but now you face additional costs that could make your total expenditure $50,000. That is $40,000 beyond your "need capacity". It can be argued this represents a 400% increase in unnecessary payments, and $40,000 in unnecessary lending.

Consumption borrowing offers the greatest levels of reward for the companies lending. It also offers the greatest levels of risk.

If borrowing guidelines get distorted, which may happen for any variety of reasons, this can cause mistaken increases in manufacturer borrowing to occur. This can lead to more distortions in consumption borrowing, which leads to more distortions in manufacturer borrowing which leads to more distortions........ At some point, the more borrowing that occurs only increases the distortions. It is here our economy is currently caught in a vicious, asset eating cycle.

The underwriting guidelines for home loans did get distorted. Because debt to income ratios (DTI) were relaxed, this means everything included in calculating DTI also became distorted. For 50 years, DTI, including what your payments would be on the home you were buying, had to be below 35% of your income for the bank to consider loaning you the money. As DTI was relaxed, first to 40%, then 50% and ultimately 60%, this also caused any other expenses such as car payments, school expenses, credit card debt etc to be relaxed, thus distorted, when calculating DTI.

The companies doing the lending began realizing greater profits from creating securities out of these loans, and selling them for large fees. When all the loans that could be packaged for new bonds were used, the companies doing the lending would stop getting the large fees. That would effect their profit, which would effect their stock price, which would effect the bonuses the executives made. The epiphany for these companies came in the fact that when they created these bonds out of mortgage debt, and sold them, they were also getting rid of (selling) the risk that might come through defaults of those mortgages. There was no need for them stop getting fees, bonuses or less value out of their stock options. Not holding the risk, and selling it to someone else, allowed the companies creating these bonds to distort their actual value.

What was the harm in relaxing DTI to allow a few more renters to be able to buy, thus creating a few more loans to make a bond out of? After all, they weren't holding these bonds, so there was no risk involved for them. If they stopped creating these new bonds, they would get no more fees for selling them. The only profit the companies that lend were realizing were coming from new mortgages and the new bonds they created from those mortgages. Because they were able to get the highest ratings for these bonds, again because of distorted models stemming from distorted consumer borrowing patterns that were different than historical norms, the market for who could buy these was growing. It carried the distortion out even further.

Now, pension funds (state, teacher, unions, etc.), money market funds, bond funds (both government and private) all were buying these bonds, and assuming the risk, because they were rated AAA, the same as a US Treasury Bond, except they were paying a yield almost twice as much as US Bonds. If you were looking for something safe, the AAA rating meant it was safe. In the case of pension funds and money market funds, they, by law, can only buy AAA rated securities. Pension funds and money market funds are also the largest pools of investment money in the world. This was not lost on the companies creating the bonds, which may have given them incentive to get the rating agencies to not scrutinize their models of performance on these new bonds. The distortions were not only increasing, they were being carried into places once thought free from effect of distortion.

As DTI was relaxed, more renters could now buy, as well as homeowners upgrade to a bigger house. Manufacturer borrowing increased as a result. Land developers, construction firms, landscaping firms, painting companies, appliance manufacturers, building material suppliers, appliance stores, big box stores and many more companies increased their borrowing to keep up with the distorted demand caused by relaxed DTI ratios which were caused by the new bond creators who were selling the risk off.

At the same time, exporting these distortions to other countries was well ingrained. By 2007, the pace of production in China supported the consumption in America at a 5:1 ratio. That means it took 5 Chinese to meet the buying demands of 1 American. The same ratio can be applied to many other countries that imported here. All due to consumer borrowing in the US. The car and "need capacity" from above is direct analogy to almost every business model in the US over the last few decades.

The US is still a major manufacturer, but what isn't said by big business is in 1947, according to the Federal Reserve Bank of Chicago, 35% of all workers were employed in manufacturing jobs in the US. By 2008, that number is less than 10%. Yes, manufacturing output has increased, but that is strictly due to technological advances and increased consumption, created by distorted consumption borrowing. It has not created more jobs here, because of the wage arbitrage conducted by the same companies that lend, as they have sent the jobs overseas for additional profits, which, again, adds to manufacturing distortions. For those that wish to argue this point is wrong, I can directly point to the fact that the US, in 1990, represented 27% of all manufacturing among the 12 largest manufacturing countries. Today, the US represents still, 27% in the same category, while China in 1990 represented only 4%, yet in 2008 represented 18% of of all global manufacturing. Yes, the US still out manufactures all other countries, yet from 1990-2008 we increased 76% in our output, while China increased 673%.

That is a direct effect of the consumption borrowing distortion. All the increases overseas in manufacturing gains have been at the expense of our increased debt, caused by distortions in consumption borrowing.

The asset eating cycle we are beginning will draw down the value of all the goods bought through consumption borrowing. Since their value was based on distortions created by relaxed lending rules, as those distortions are eliminated (no more 100% financing at 60% DTI), their value will decline. All consumption borrowing used to finance cars, boats, houses etc will realize falling values of those goods. Many are now caught between what they owe, and the current value of what they bought through borrowing. If you must sell your house today, you will probably not get what you paid for it two years ago. If you must sell your car because you cannot make the payments, you may owe more than what someone is willing to buy it for. The same with boats, vacation homes, appliances etc.

What is more troubling is the loss of real wealth. Since many retirement and investment programs bought these new bonds, which were based on mortgage debt and other debt that was securitized, they are realizing catastrophic losses. As the underlying debt loses value, so do the new bonds. Many pension funds have been decimated, with some losing all value. That means workers who paid into a fund for 40 years, and thought they were getting a pension, now will get nothing. Money market funds have already "broken the dollar", meaning they are losing value because they bought these new bonds.

The distortions created by the companies that lend lead to over-borrowing. In the quest for greater profits, these distortions were carried into every corner of the globe. As the assets underlying the new bonds fall from the artificial peaks they attained due to distorted consumption borrowing, so will the value in these new bonds. Considering there are over $500 Trillion of these new bonds sitting in accounts all over the world, a loss of 50% in original value, which is an optimistic return, certainly doesn't sound good.

The Federal Reserve has, to this point, only taken in $2 Trillion of these new bonds, and the stock market went from 14,000 to 7000. What happens if they try to assume the losses of $100 Trillion?

"Why It's Actually Different This Time"

Trying to find the bottom in the market feels like looking down the shaft of a 2000 ft deep well.

The spasms in the the charts belie the simple fact that many corporations have substantially more debt than income, and are likely not to make it in the long run. Placing money short or long has been, as the market guys say "like trying to catch a falling knife."

Writing for Seeking Alpha, Lee Eugene Munson and Patrick Kirts draw broad, yet correct, strokes of the state of the economy in "Why It's Actually Different This Time." Importantly, they explain why, and identify many important hurdles before us.

"A few things lead us to think we are in worse position in 2009 than in 1974 or 1932. For one, we've fallen deeper and faster than we did in even the Great Depression, let alone the mid-70s. It took years to reach the lows in the last two events, but only a year and a half ago, we were at 14000 on the DJIA.'

"We are also now in a very different geopolitical position; Western nations are net debtors, and Asian countries are now net creditors. After World War I, the US and Britain were the world's creditors. Now, savings have dried up, both for countries and a great number of individuals in the West--and the US is in the most debt of all. We cannot fund our own recovery. On a related note, it is clear that the Obama administration has a shrinking window of time to address our economic woes, but each new action seems to add to the pessimism and uncertainty."

".....the US faces a demographic problem it did not face during the Great Depression..... In the 1930’s there was no retirement or thundering herd of people living off portfolios and not working. We had no cost containment questions relating to healthcare or the pervasive need for all young people to go to college and indebt themselves....."

"During the past decade.....the largest destruction of resources in history occurred. The fall in the prices of the 'assets' whose 'value' rose so much during this period is the necessary precursor to the redirection of capital to more productive--that is, wealth-creating rather than wealth-destroying--efforts."

"Wall Street and Washington, however, seem to see the situation quite differently. The actual functioning of the market economy seems lost on them, even on most of the 'free-marketers'.... Thus, what must be stopped is the fall in asset prices. This type of thinking cannot produce recovery, because it dictates a response based on easy money and debt, the same things that created the problem."

"Using Depression era metrics, experts estimate actual unemployment at almost 15%. But it took until the end of 1931 to reach this point...."

"Only when the economy starts producing profits will a turnaround be possible, and this cannot happen until the losses that have piled up are fully realized.... Capitalism depends upon both private reward and private loss. Right now, that is not happening. Government bailout money is simply keeping unmarketable assets inflated to protect the balance sheets of the most politically connected in the finance industry."

"The Federal deficit is projected to be 12.26% of GDP in 2009, up almost four times from the 2008 proportion of 3.21%. This new debt could cause extensive problems for the dollar and dollar-denominated assets." "The world derivatives market is now many times, perhaps as much as ten times, greater than world GDP. A serious disturbance here, where not only financial institutions but also many corporations mathematically manage their risks, could be catastrophic."

".....an objective appraisal of the larger economic facts almost requires a pessimistic outlook. Jim Rogers may be overstating things when he describes current US policy as 'ridiculous' and 'insane,' but we can't be sure he is wrong."

Fixin Profits

So, the Merrill Lynch traders erroneously booked profits, to hit bonus targets, just before time ran out. As soon as they received their bonuses, the numbers were, of course, revised. This, from the NYTimes via Naked Capitalism;

"Mr. Cuomo claimed that Merrill traders had mismarked their books as of early December in an effort to get higher bonuses."

“It appears that some of these losses may have been booked by Merrill employees who marked down their portfolios only after their 2008 bonuses were set,” the attorney general wrote in the filing. “Despite the gargantuan unexpected losses, Merrill did not reconsider its bonus awards” and Bank of America did not request or demand that Merrill reduce its bonus pool, he wrote."

Send the following to any of your friends that think Cramer gives them advice that is, well, honest.



It appears Cramer may use his show to get you to buy, or sell, a stock that he has a contrary position in. He implies that he does this often. Inquiring minds may wonder how many put contracts he had in play the day he told everyone to get out of the market.

Oh, and he thought he could explain this to the interviewer because "it would not be on TV."

Thanks to the Huffington Post and MLImplode for reposting this. I had seen it a couple of years ago, and have thought often about putting it up.

Add to the list of should be jailbirds all the management and traders at Merrill Lynch, as well as Cramer and many of the songbirds at CNBC. There is no way in the world the leaders in the US should think foreign money will help support our markets when the evidence grows, by the day, they are clearly rigged.