See, I told you so....

In the report, the panel, that includes Rob Johnson of the United Nations Commission of Experts on Finance and bailout watchdog Elizabeth Warren, warns that financial regulatory reform measures proposed by the Obama administration and Congress must be beefed up to prevent banks from continuing to engage in high risk investing that precipitated the near collapse of the U.S. economy in 2008.

The report warns that the country is now immersed in a "doomsday cycle" wherein banks use borrowed money to take massive risks in an attempt to pay big dividends to shareholders and big bonuses to management – and when the risks go wrong, the banks receive taxpayer bailouts from the government.

As the report says:

I'm going to write today about a very somber subject.  It will be, as it usually is here in one form or another, about math.

First, some background.  If you believe that we have "escaped" from the mess that gripped this nation in 2008 and 2009, or that said mess "suddenly appeared" and "nobody saw it coming", stop reading now and have your Thorazine dosage checked.  It's way off.

Assuming you accept the truth - that this mess was 20 year or more in the making, that it involved creating credit (that is, debt) which the debtor could never pay, and that it still exists because our government policy has been to extend, pretend and allow lies that should be considered accounting fraud and result in prison sentences, then you're on the right page to understand the rest of this missive.  Again, if not, go check your Thorazine dosage.

Yes, I know all about the stock market rally from last March.  I know all about the claimed GDP "improvement."  But I also know that we got both by adding more than $2 trillion in debt to the United States - or roughly 14% of GDP - over the space of the last 18 months.  That's about 10% of GDP annualized, and incidentally, a 10% GDP contraction is the common economist's definition of an Economic Depression.

So let's cut the crap - we are in a Depression right now.  We are pretending we are not, just like you can pretend you didn't really lose your job so long as your credit card does not reach its limit.  We have been in that depression for about 18 months and there is no evidence that we will exit it, as we have yet to find a way to pull back the deficit spending without an instantaneous collapse in the economy.

Yet at some point we must and will stop.  We will either do so of our own volition, or we will do so when the cost of borrowing skyrockets, as others get tired of funding our profligacy.  If we attempt to "print" our way out of it the cost of petroleum products will shoot the moon and destroy our economy anyway.

You haven't seen the half of what happened though - not yet.  It appears that AIG - the company we have bailed out (thus far) to the tune of some $100 billion plus, in fact isn't done.  It appears they may have written credit protection on Greece.  If this allegation by the German equivalent to The New York Times is true Americans are going to be asked to pay billions of dollars - or more likely, hundreds of billions (since Greece is almost certainly not the only place - try Spain, Portugal, Ireland, etc) to bail out a bunch of FOREIGN NATIONS.

Do you both think Americans can and will pay that bill?  A bill that has been forced on us, and yet benefits not The United States economy, but foreigners? 

Wars - big wars - start over much less, my friends.

Oh, and let's not forget - some 30% of Greece's workers went out on strike to protest their "austerity measures."  That's right - one in three.

The Fed and our fabulous Treasury Secretary already gave tens of billions of our hard-earned money to foreign banks to prop them up via AIG.  That was just a down payment; now we all get to - quite literally - buy all their houses over in Europe.  They get to keep living in them.

If you do not believe it is going to get much worse than it is now, economically and otherwise, you once again need to go have that Thorazine dosage adjusted.

A recent Rasmussen poll disclosed that only 21% of the voters in this country believe that the government enjoys the consent of the governed.  Put another way, only 21% of the voters in this nation consent to what Washington is doing. 

More ominously, 61% say the government does NOT have consent.  The remainder (18%) are not sure.

May I remind you that in 1776 less than that 21% of the population (19%, actually) were loyal to Britain?

If you do not believe this nation is wound tighter than a clock spring, you need to have that Thorazine dosage checked again.

You are in denial. 

After denial comes anger, then bargaining, and finally acceptance.

Let's not do anger on a mass scale in this country, ok? 

Neither I or my daughter will appreciate it if it happens; shall we skip that and go right to "acceptance"? 

Let's assume your answer is "yes."

Now let's talk numbers.

There are approximately 150,000 federally-attached law enforcement personnel.  Another 750,000, roughly, state and local cops are employed by our various government arms.  Of those various officers well more than half sit behind a desk and haven't left one gram of shoe leather on a street or in a cruiser in the last year.  The majority of you fire your weapons for periodic qualification and they have never been warm or dirty besides.  You've never faced death, you've never had a weapon pointed at you in anger, and you've never drawn your service weapon in the line of duty.  Those are facts.

Now consider the "bad side" of America.  The Justice Department estimates there are at least one million gang members - active gang members - in America.  These people, mostly young males, have nearly all drawn or fired weapons in anger.  They are responsible for more than three quarters of all crime in this country, and some eight out of ten violent crimes.  Those gang members have families - younger males who are "coming up", "friends" (if you can call a murderous thug a friend) and others.  Between all of those "loosely attached" folks and the hard-core inner circle itself we probably have somewhere between 5 and 10 million people in this nation who, given the wrong sort of provocation, might decide that "Zombieland" wasn't just a movie.

Our politicians created most of these monsters so the "finest" would have something to do.  A nearly-100-year obsession with what consenting adults put in their bodies is largely responsible for this, and an intentional policy of allowing an effective invasion of illegal aliens over our southern border provides some the most-violent core of this group.  The illegal drug trade has fueled international wars, international gangs, and virtually all of the organized violent crime in this nation going back to Prohibition.  Essentially every automatic weapon in the hands of criminals (and there are plenty of them) comes into the US through this same intentionally-left-open border as do the gangbangers, lies of this (and previous) administrations notwithstanding.  Those of you in the Law Enforcement business may not want to accept these facts, but if you reflect on it you cannot escape reality: weapons, ammunition and other means of street thuggery all cost money, and without these drugs being illegal there would be no profit in it, and thus a huge part of the criminal gangland element would not exist.  You've cheered on the War on Drugs as it has meant more cops being hired and more, better, fancier toys for you to play with, along with $200,000+ pensions (in some areas.) You've been fools and even self-destructive assholes for having done so.  But that, today, is water over the dam - the bad guys are here, they're not leaving, and there's no evidence that the political class is going to suddenly legalize these substances tomorrow, cutting the source of funds for the thugs off at the knees - after all, you won't rise up and demand it happen.  So we must deal with reality on the ground as it is (and as you have cheered on the creation of), whether we like it or not.

As I'm sure you're aware all of America sees some of our "finest", not to mention our politicians, in various forms of misbehavior virtually on a daily basis.  A girl beaten on a train platform while uniformed rail security stands and watches.  A young man who appears to have been executed by a different rail security officer, even after he was subdued, face-down, without a weapon and easily able to be cuffed.  The infamous Rodney King incident.  The false accusations against the Duke Lacrosse team that threatened young men with many years behind bars for something that never happened.  Our current Treasury Secretary who cheated on his taxes, not to mention the chair of the House Ways and Means Committee who did as well (that's the committee that writes tax law, if you're not up on your American Government.)  And now, in the latest bit of ignobility we're expected to swallow, we have accusations that a school district has been taking pictures of kids in their bedrooms using state-issued laptops that said kids were required to accept in order to pass their high school classes.

Here's the problem: We the people increasingly don't trust you, the law enforcement community, and we definitely don't trust Washington.  It's not just beating a black man within an inch of his life, or shooting a prone, subdued suspect in the back. 

Oh that's bad enough, don't get me wrong, but it gets worse. 

Much worse.

See, our economy wasn't ruined by accident.  These crimes of economic activity were every bit as destructive, if not more so, than the bank robber, rapist or even murderer is.  These economic offenses have literally dispossessed millions of Americans of everything they once owned.  They have destroyed the hopes, dreams, and lifestyles of entire cities, sent tens of millions of jobs overseas into slave labor camps and stripped off the wealth of our nation through the issuance of securities that were worth nothing, just to add insult (and yet more profit for these banksters) to injury.  Take a drive through Detroit if you doubt me, if you dare, and are appropriately armed to defend yourself (you'll need the latter, especially if you're white.)

As I noted above the bad news is nowhere near being over.  We're denying as a nation, as corporations, as politicians and as people.  You've drank your coffee and eaten your donuts, but what you haven't done is taken the initiative and marched down onto Wall Street and K Street (in DC), along with the myriad bankers, mortgage brokers and yes, even borrowers who were lying and cheating at the same time.  You should have broke out the handcuffs by the crate-load and frog-marched these people into the dock en-masse over the last two decades, but you didn't.  You should do it today, but you won't.

I know, you don't make the laws and you just follow orders from above.

But you're who we see.  You're "The Badge" or "The Squad."  And what we, the people don't see is perp walks of those people who richly deserve it - who have in fact broken the law and destroyed our nation's economic vitality for their own personal profit.

Remember, ladies and gentlemen, no matter what branch of law enforcement you hail from, your primary oath was not to a person.  It is not to your commander, your captain or your squad. 

Your oath is to The Constitution.  You swore to defend that Constitution against all enemies, foreign and domestic.  You swore to God and countryman alike, and your oath does not have a "use by" date at which point it expires.

Now consider this: the unspoken "social contract" says that the good guys go about their business without harming other people, and the occasional miscreant commits some offense, gets arrested and put in the dock by you.  There they face their twelve, and in many cases subsequently do their time.

But what really inhibits the miscreant from his deed?  Is it that you will show up and take a report after the stereo is stolen, the car burgled or the bank robbed, and attempt post-hoc to have them face the music?

No.

It is the possibility that he will break into or attempt to rob a home or business that has an armed citizen in it who is prepared and willing to defend him or herself.  Armed not only with the ability to fight back but the weapon of familiarity of surrounding, said homeowner or shopkeeper might well splatter the brain of said felonious thug all over the far wall - in righteous and perfectly-legal defense of one's person (except in places like Chicago, of course.)  The truth of this is clear on its face - those places where citizens are "restricted" (illegally, I might add, under the clear language of our Constitution) from mounting their own defense to rape, robbery or murder the bad guys pretty much take turns "at will", as opposed to places like Kennesaw Georgia which mandate instead that every homeowner have a firearm and ammunition.

One last thing to consider, and I will leave you be, as I have others to address this fine day.

If it gets bad, and I believe both history and the math says it will, who's going to help you?  Do you really think the entirety of the 150,000 Federal Officers will come to your aid?  Or will they sit in Washington DC and in their big black Suburbans (armored, of course) issuing orders for you to go into the streets in your (unarmored) Crown Vics and die in their place?  Remember that the "bad guys" in such a circumstance outnumber you 10 or even 20:1 and not only are they probably armed as well as you are, they've actually shot - offensively - at other human beings.  Unless you're one of the "bad cops" you've never done that, and few of you have had to fire in self-defense.  Your only realistic advantage in such a situation is that most of the gangbangers are pretty poor marksman.

What's the outcome of such an event likely to be?  Remember, we may distrust you,  but the bad guys hate you to the core and would BBQ and eat you for dinner if they thought they could get away with it.  If things get bad they might deduce - en-masse - that they can get away with it.

Let's face facts: while today we all count on being able to pick up the phone and call "911" if we need an officer to take a report on our stolen stereo, if the bad times come you will need us, not the other way around.  We the people will, under such a circumstance, have the luxury of determining whether your oath of office has been faithfully discharged, or whether the only difference at that instant between you and the gangbanger is that you've got a fancy hat and a nicer car.

Most of us, should we determine that you're just the thug with the fancy hat will hide under the desk.  We won't shoot at you - that's not our way.  We're law-abiding citizens, for the most part, and while we will shoot back, we won't shoot first.  But what we won't do is help you, because your time - your opportunity to help us prevent this catastrophe - will have expired.  We will protect our neighbors, our friends, our fellow citizens.

But that's all. 

You will get to deal with Zombieland, and in the back of your mind as you're literally consumed will ring that old saw you laid on us for the last two decades: "I just follow orders; I don't make the rules."

Be honest with yourselves: Is this where you want to be, or would changing things now be worthwhile?  Would regaining the trust of the people be a good thing?  Would replacing the large percentage of law-abiding citizens who now would spit on your shoes with those who will stand shoulder-to-shoulder with you, weapons facing the oncoming zombie hoard, be a good thing?

If so you have some work to do and there's still time left to accomplish it.

To the politicians who are reading this, your Thorazine dosage needs adjustment as well.  The math is irrefutable.  If, in point of fact, AIG has entangled itself with the European Continent there is no escape from what is to come.  There is only destruction, and our only two choices are to cause as much of it as we can to occur there, by pulling the plug on these clowns now, or risk a literal World War.  We may get one anyway, but if we bring the bulk of the damage here we'll be dealing with a civil collapse at the same time, and have no chance of being able to deal with the geopolitical implications.  We must not allow that to happen.  You must not allow that to happen.

We understand you give the orders to the people I've been talking to (mostly) up above.  But you have less excuse than they, when it comes to oaths.  You all took an oath to uphold The Constitution as well.  You've used it as toilet paper, and that's on a good day.  The rest of the time we see you gleefully burning it in the Wells of the House and Senate, dancing around the smoke and fire like some odd pagan ritual.

It's time to stop.  Not because you want to, not because you fear us (even though you should - after all, we're your employers and can fire you) but because if you don't there won't be a nation worth governing left.  You know who the crooks are - including those among you. 

Let's talk taking this nation back.

It starts with declaring all CDS written against sovereign debt, directly or indirectly, void as contrary to public policy.  Yes, that cuts Europe off from any prospect of a US bailout.  So be it.

Next, all the banksters who were involved in these bogus securitizations need to be hauled into the dock.  Now.  William Black and his merry men sent over 1,000 people to the slammer in the S&L crisis.  There are ten times that many who need to go this time.

Third, force all credit-default swaps onto a public exchange with published bids, offers, last trades, open interest and nightly margining.  In public, where we all can see it.  Either that or ban these obscenities outright.  Choose one, and only one of those two options, and do it now.  Yes, I know the banksters will howl.  Too damn bad, and while you're at it, make it unlawful for any institution that does business in this country to transact in any way in any instrument that does not comply with that rule.  This monster, as I've been writing about for almost three years now, must be caged.

Fourth, reinstate Glass-Steagall.  Yeah, I know, the Senate doesn't want to do it.  The Senate wants a nation that's worth governing though, right?  We won't have one if this crap isn't stopped.  Mssrs. Glass and Steagall had it right in the 1930s.  Put it back.

Fifth, stop lying to the people - and this includes lies told through deficit spending.  We don't have the money and can't keep borrowing it.  If you don't stop we will find the "knee point" the hard way, at which point once again, you won't have a nation worth governing.  Remember the four steps above - neither I or my daughter, nor most of the 330 million Americans in this country, want to see the "anger" phase.  Our country is like a powder keg and every time you lie you're playing with matches in the room.  Stop it before you blow us all up.

Sixth, we're in a Depression, like it or not, and we're not going to get out of it until the bad debt is defaulted and cleared from the system.  Your job is to make that happen and get it over with.  That's deflationary.  Sorry; this is math, not politics.  The housing bubble was a hyperinflationary event - one hidden from the people by bogus government statistics and outright lies.  Deflation always follows hyperinflationary credit booms - it's either that, or the destruction of the government, political system and currency.  You choose, but if you do not decide, destruction it will be.

Seventh, close the damn border and declare all the illegal immigrants as what they are - invaders.  Tell them to either leave or will expel them - and mean it.  Declare "LaRaza" a terrorist organization and lock 'em all up.  Americans need the jobs and we cannot afford to have five or ten million thugs just waiting for opportunity in the smallest loss of civil order to swoop in and take advantage of us all.  At the same time, drop your insane "War on Drugs" and replace it with a taxation, regulation and legalization structure.  Yes, I said legalize - federally.  While we still have time we must cut off the chief funding source for the murderous thugs who otherwise, given the opportunity, will feast on you after they BBQ the local and state law enforcement crowd in our major cities.  Don't BS me or anyone else with your claims that such isn't a real risk - I don't see you strolling around in your fancy suits through the bad parts of Washington DC sans security details.  Gee, I wonder why not......

Finally, to President Obama.  You can't serve both the banksters and The American People.  You took the oath of office too.  Now you have to choose.  Not only will you lose in 2012 (badly) if you don't start locking up the jackasses that got us into this mess but if you don't ram the above seven points down the throats of these banksters and others in the next couple of months your party will be decimated in the November elections.  Some of your oldest allies in the Democratic Party are resigning; Senator Bayh, for example.  Illinois' State financial health is akin to someone with terminal pancreatic cancer, and that's where you're going home to in 2012 if you don't quit being nice-nice with people who have played rape-rape to the American people and economy for the last two decades.  You didn't make the mess (you weren't around long enough to do it) but you had damn well better clean it up, or what will be left of this nation is unlikely to be worth governing by the time your term expires.

Health care may be important but not until the above is taken care of.  Fixing the financial system is the issue you must confront and fix in its entirety.  Not half-way, not by compromise - you simply must fix it.  The seven points above are not options, they're not discussion points - they're mandatory.  All of them.  Don't believe me if you don't want to - believe Charlie Munger, one of the wisest investment professionals ever to live, and, in my opinion, the smarter half of Berkshire Hathaway (with no disrespect intended to Warren.)

The choice is yours Mr. President, but the consequences will belong to all of us.

Choose wisely.

I will probably draw comments like "you doth protest too much!" for this, but I think it's important.

My exchange in email with Jonathan Weil over my "Whistling Past The Graveyard We Be", in which he originally took umbrage over my "soft" characterization of him being late to call things what I believe they are (that is, fraudulent misconduct) rather quickly turned into my rehashing a piece of my Ticker on synthetics a couple of days ago, pointing out that this, plus the removal of leverage limits, plus generally bogus accounting and willful blindness are the primary reasons we're in this mess - and that none of this is a "mistake". 

His ultimate reply to me was that there was no point to arguing with a crazy person.

Well, if I'm crazy for my refusal to believe that any of this was an accident or mistake then I'll wear that badge with pride, because I cannot square any of what has happened thus far, nor the road to Hell we are presently on, with the generalized idea that any of this was an accident - or a mistake.

To the contrary - it is my considered opinion that nearly the entire last two decades of our so-called "Economic Progress" has been defined by parties all trying to screw one another in any form or fashion they could manage to pull off.

Back in the 1990s I saw a metric ton of this while running MCSNet.  We would get a literal dozen or more calls a day from people who wanted accounts to access the Internet - but they first asked our customer service representatives if we carried certain material that was flatly unlawful to possess or distribute, including groups linked to stolen computer software and child pornography.  We didn't, we said so, and they went somewhere else - usually after loosing a long string of obscenities at the employee who delivered the news.

Internet firms of all stripes were claiming Internet growth rates of 30% or more per quarter during the 1990s - in many cases right up until it all blew up.  It was a lie - that growth rate in the Internet was a couple of quarters in duration, corresponding with the release of Windows 95.  This is a fact that thousands of people knew because we, along with those others, had access to the Internet's "core" routing tables - we had to in order to do our job.  Yet this lie was repeated by company after company in conference call after conference call and drove much of the speculative Nasdaq Stock Bubble.  When it collapsed everyone who believed in that lie got creamed and millions of Americans lost (effectively) their entire investment account.

But let's return to the present mess, shall we?

It's not an accident when you create a security because some hedge fund manager (even if a really bright one) comes to you and wants to short something - so you give him a means to do so, and then sell the other side of that off to people without telling them how it came into existence in the first place, including how, why, and at who's behest and for what purpose you created it.

It's not an accident when you run up against leverage limits (as Goldman did) and your big cheese (Hank Paulson at the time) goes to the SEC and gets them to remove that leverage limit for investment banks - then the two investment banks that subsequently fail, Bear Stearns and Lehman, both do so after more than doubling their leverage beyond the former legal limit!

It's not an accident when a whole host of Wall Street (and Main Street!) banks willfully and intentionally ignore FBI warnings in 2004, a Corelogic credit survey in 2006 and HUD study in 2007, all of which warned of rampant mortgage fraud and lies about incomes in 50% or more of "ALT-A" loans, packaging up that debt and selling it to investors without warning them that the so-called "quality" claimed in those loans was almost certainly - in the opinion of both government agencies and private credit analysts - simply not present.

It's not an accident when the ratings agencies also ignore these warnings - if there was a group of companies that should have been the ultimate experts on such matters it is S&P, Moody's and Fitch, all of whom either had to know or should have known about the warnings by The FBI, Corelogic and HUD, never mind their (admitted) computer models that omitted any possibility of home price declines.

And it's not an accident when you have the Realtors(R) chief economist penning not one but two books claiming that the housing bubble would not bust (with an implied "ever"), even though two minutes with Excel (or a rudimentary understanding of grade-school mathematics - exponents, to be precise) will disclose that it is flatly impossible on a mathematical basis to grow debt faster than GDP on a permanent basis without a bust inevitably taking place.

Now not all of this is actionable - or criminal.  Indeed, I can write books pontificating on all sorts of fanciful things all day long, and unless I missed something being completely full of it (as many of the books on economics, business strategies and investing are!) there's not a thing wrong with doing so.  If someone's willing to pay $20 for a bunch of bound pages that contain nonsense, that's the buyer's problem in the general sense, not (usually) the author's or publisher's.  That's because I can offer my opinion all day long and as long as I'm not inducing someone to engage in some sort of action by which I will profit in some form or fashion, and am thus trying to get someone to commit (or not commit) an act as a consequence of my speech I have no obligation to be either intelligent in the presentation of my opinion - or even truthful.

This, incidentally, is part of why it's not unlawful (civilly or criminally) to lie as a politician - all he or she is after through their speech is your vote, and it's flatly illegal to buy or sell those (even though we know people do!)

But things are different when one purports to sell securities of various sorts, or for that matter when one intends to engage in commerce generally. 

We have laws about that, just as we have laws about various forms of financial statement and requirements that they be rendered honestly.

We all file statements every year that are supposed to represent the truth - they're called tax returns.  You can go to jail for lying on them, although few people do.

In the commercial world I can't sell someone a car that knowingly has a tampered-with odometer unless I disclose it.  There's a checkbox on the back of my title for that - "mileage not actual" - and if I don't check it, and I lie, I can be punished.

Under the general body of law I cannot intentionally screw someone in any form of commerce - that is, withhold information from someone on purpose or lie about what I know for the purpose of getting them to act in some fashion (like giving me money for some investment) when that which I either do know or should know and either lie about or intentionally omit would lead a reasonable person to not hand over their cash if they were informed.  If that act of intentional omission or lie leads the other person to be harmed I have committed an offense, and in many cases that offense is both a civil and criminal matter.

This sort of conduct, however, has become literally embedded in virtually all forms of our lifestyle, and I would allege that a big part of "why" is that it is almost never punished. 

How many stories about crooked used-car dealers have you heard?  Got a fax machine?  If you do you've probably gotten dozens if not hundreds of "pump sheets" for various over the counter stocks - all claiming "huge profits" to be had by buying X.  These are illegal in nearly all cases by the way in some form or fashion, but I gave up forwarding them to the SEC and FBI more than a decade ago - they don't care.  During "Cash for Clunkers" there were stories in the media (which I reported on) of dealers demanding "side letters" that would cause you to lose if they failed to properly file the paperwork and the rebate was denied - side letters that, incidentally, the government said were improper.  Was anyone led out in chains over that?  If so I didn't see it on TV.

How many "homeowners" lied about their incomes when they applied for a mortgage or refinanced?  Millions.  Many more had paperwork changed by unscrupulous brokers, and there were posts all over Internet Discussion Boards talking about how to "game" the various automated underwriting programs that were in use toward the end of the bubble.  The FBI even separates it out - "fraud for housing" (lying to get a house) which they considered unworthy of their time to prosecute, even though any lie on a mortgage - or other credit - application is a federal offense.

If we are to have an honest and productive economy this must stop in all of it's forms, and the apologists for this sort of behavior must be shown the door.

The Media's job in no small part is to report on these lies.  For each of these events of deception and screwing that takes place trust in our economy generally and our capital markets specifically is damaged.  It is one thing to place a bet in a casino knowing that the "rake" guarantees the casino will make money over time, but it is quite another to wonder whether the dice are loaded, the cards marked or the railbird behind you is secretly communicating your hole cards to the guy on the other side of the table.

When society and commerce degenerates into "screw the other guy harder than he's screwing you" then you have lost the ability to prosper through innovation and hard work, replacing it instead with a Tony Soprano world in which certain "privileged" people, either by political donations or outright grift are allowed to screw anyone they want with impunity while everyone else is forced to either risk being caught (and punished) committing their own scams or become a serial victim and have their wealth and earnings mercilessly stripped.

Elizabeth Warren's latest report was outlined on CNBS this morning as being focused on commercial Real Estate, but she also make clear her view on "tricks and traps" in all forms of finance - and on this point she is spot-on.  Pay attention about 2:50 into this clip:

Steve LIESman tries to go after Ms. Warren, but all he does is give her more opportunity to make her point - that the entirety of Wall Street, for the most part, has been focused on tricks and traps.

Gee, you mean in addition to not disclosing what was going into these securities that were sold off to duped investors (who ultimately lost their money) they were doing it to consumers too?

We cannot have a strong economy that is, at its core, all about trying to screw people.  If that's the premise on which your business rests, whether you're a commercial bank, Wall Street investment house or any other business then YOU SHOULD BE CLOSED DOWN.

Now tell me why THE MEDIA is siding with the tricksters and grilling those who are trying to put a stop to it.

While wishing for actual enforcement of these laws by the very politicians who lie to us every couple of years to get us to vote for them (cough-Eric Holder-cough!) may be asking for too much, what's not too much is for each and every one of us to REFUSE to do business not only with any firm that pulls this crap, but any firm that does business with those that do!

We the people can stop this - if we care to - it starts and ends with us.

It has taken nearly three years since The Market Ticker began publication in April of 2007.

At the time I said:

To control that risk, banks, which used to hold mortgages on their own, started "securitizing" these loans and putting in tricky features to control that risk.

That has allowed the banks to get away with this. See, banks have FEDERAL guidelines they must maintain in terms of loan safety. Why? Because the FDIC has to bail out banks that fail! Remember the S&L crisis? That was caused by S&Ls making risky loans that couldn't be repaid. Banks know all about this stuff, and they're very cognizant (since there was a blowup in their sector among the thrifts) of what happens when you do that.

So to keep their feet out of the frying pan, they figured out a trick - they shoved off the mortgages to the general debt market! Adding to this the mortgage folks figured out that they could take a "bucket" of mortgages, sift them into baskets that were categorized by loan-to-value and FICO score, assign those a risk premium and then sell them in the market as "tranches" of debt - essentially, converting the mortgage to a bond. By doing this the bank is (mostly) insulated from the risk that you won't repay the loan, because once any recourse written into the contract has lapsed, the risk passes to someone else - the bondholder.

And now The New York Times has opined with:

If economists and regulators had recalled the securitizations of the 1920s, they might have realized that the recent boom in real estate securitizations was not what they took it to be: a result of American financial ingenuity that created ways to spread risk to those who could best afford to bear it and in the process made financing more available and less expensive.

It was, instead, the same old speculative enthusiasm, even if it was wearing fancy new clothes. Investors who had seen real estate prices rise thought that trend could not end. Wall Street sharpies thought they had found a way to make lots of money while not bearing the ultimate risk if the game suddenly ended.

As it turned out, the sharpies were wrong. They too got swept up in the carnage — just as their predecessors had in the 1930s.

Uh huh.

Some of us did see this folks.  It has taken The New York Times three years to figure it out, but they're the "tout media" - mainstream newspapers who (just like Tout TV) cannot imagine actually thinking about what these "complex" securities really are.

The simple fact of the matter is that complexity isn't good, it's bad.  It's bad because it costs money.  This means that as complexity increases yield deliverable to the actual buyer of that security - that is, the earnings power of that security, decreases.

The ugly little truth as I have repeatedly pointed out is that in any lending transaction there is a fixed amount of potential profit - that being the spread between what the borrower pays and what a true risk-free transaction entails at that particular moment in time for an identical duration.  That's all there is and that's all there will ever be.

All lending transactions that are more complex than two people sitting across a table with one lending the the other money therefore must have a loser.  That is, either the borrower must overpay for the money (compared to actual risk) or the lender must be undercompensated for the risk he is taking.  In a marketplace where there are many lenders this risk will inexorably fall on the lender because the borrower will shop for the lowest possible price of the money.

The factual and mathematical reality is that if we want stable lending then we should demand an end to securitization.  The proponents claim that doing so will instantly implode capital access for those who want to borrow over long periods of time (e.g. real estate loans) but are not in the position to issue their own bonds such as mid-sized and larger corporations can do.

This is a false assertion.

There is nothing preventing a simpler structure from working perfectly well.  That is, those who have capital and want to lend it for longer periods of time (so-called "traditional" buyers of MBS and similar instruments) can just as easily buy longer-term bonds issued directly by banks and insurance companies.  Those firms can then lend directly to homeowners and commercial property developers and retain the loan on their own books.  Since they have the capital from their lender to do so duration matching is not a big deal; if they borrow the money from an investor (by issuing a bond) and their borrower prepays they can then re-deploy that capital to another borrower for the remaining portion of the term.

This, by the way, was why and how lending worked for most of the stable period in our banking system's history after The Depression.  Most lenders indeed did hold their own loans - some were sold off, but not all as is the common practice today.

What "de-constructing" securitization does is cap the use of leverage by the banks and other financial institutions to "gear up" their returns, restricting it to the the reserve ratio for banks and other financial firms.  This in turn dramatically reduces both the risk of catastrophic losses and removes the fuel necessary to drive speculative asset bubbles.

The entirety of the pronouncements thus far out of Washington DC and Wall Street is aligned with the idea that we must find ways to "re-ignite" the securitization machine.  This is not only false it is fanciful.  Securitizaton and all the complex BS "financial magic" that surrounded it was the cause of the debt-based credit bubble that enveloped the economy from the 1990s forward and it not only must not be re-ignited it can't be re-ignited as the bad debt has not been cleared from the economy and as such there is simply no more borrowing capacity at below-market rates of interest with which to play this Ponzi game any more.

A return to sound lending - where lenders hold the loan and thus the risk, and those who wish to lend but are not in the position to originate themselves place capital with those who are, is the correct way forward. 

Forcing banks to remove proprietary trading from their deposit and lending activity (e.g. "The Volcker Plan") is a good first step, but not sufficient.  Glass-Steagall kept the banking system sound for fifty years and it was only when we started tampering with it, first with the S&Ls and then by dropping it entirely, that we had major problems.

We could avoid those major problems if we would enforce the general statutes barring fraud in all its forms, but that, with a captured government and Wall Street fawning all over people like Barney Frank and the entire cadre of Senators has proved to not work.  They simply will not demand that the law be enforced and we the people are too soft and willing to be repeatedly violated to rise up and make this the single issue upon which we will demand action - instead we allow ourselves to be divided and diluted with great-sounding issues like abortion and the so-called divide between "left" and "right."

Here's reality folks: Without a fundamentally-sound economy predicated not on speculative excess but rather on honest return-for-risk acceptance and industry none of the other issues matter.

All the pressure groups and indeed the posturing of the Harry Reids, Nancy Pelosis, John McCains and Sarah Palins are designed to do exactly one thing: Keep you from talking about the single issue that has driven corruption in our political and business space for the last thirty years and upon which the entire Ponzi Scheme that we call our "economy" and "government" today rests.

If we the people were to demand and resolve that problem the entire edifice of fraud and corruption would collapse for lack of return on the "investment" of buying politicians.  That is, if the penalty for re-confirming Ben Bernanke, who we know for a fact was not only advocating for the bubble economic policies before was appointed to head The Fed (while working for Greenspan's Fed) and who has been wrong in virtually every single economic pronouncement he has made over the last five years was an immediate assembly of 3 million Americans on The Washington Mall (1% of the population) who then refused to leave until every Senator who so voted either resigned or Bernanke stepped down we would see results. 

If the result come November was that every Senate seat in contention where that Senator voted for Bernanke's reconfirmation was sent home and replaced, irrespective of all other issues, we would see results.

If the result come November was that every House seat in which a Representative voted for TARP in any of it's forms, again, irrespective of all other issues, was turned over to a new Representative and the old ousted and sent home, we would see immediate results.

We all want our cake and to eat it too.  But that's not possible.  All Ponzi Schemes must fail due to the fundamental mathematical reality that the so-called "returns" promised can only be achieved by finding a greater and more-gullible sucker who will pay more than you did.  Inevitably the supply of suckers must run out as the number of people with capital has a finite supply, and when it does the collapse ensues.

We can either continue trying to re-inflate a popped balloon and live in a world where everyone measures "success" by how many points the DOW went up or down, or we can decide that the only issue that matters to us as Americans is returning to a definition of "success" that excludes Ponzi financial activity explicitly and, if necessary, by force of law, relying instead on industry and production - that is, a return to measurement of success based on mining, growing and manufacturing.

The only "free lunch" on this rock we call Earth is the energy from The Sun, and even that will end, albeit long after we are all dead.

Wake up America.

Let's score the 2009 edition first:

• The economy will NOT recover in 2009:  I'll take this one, although some would argue I only deserve half (I said 8% unemployment U3, we actually got 10%.) 
• Deflation, not inflation, will become evident well beyond housing.  Miss.  Valid if you look at energy, but the "well beyond" includes a meaningful subset of the various things people buy.  Nope.
• Housing prices will continue to decline: Direct hit.
• The Fed's attempt to "pump liquidity" will be shown to be an abject failure: 1/2 a point.  Certainly if you look at stock prices, it's a miss.  If you look at whether credit creation was stabilized and increased, its a horrifying score.  We did get the instability in the dollar, but no bond market crash.  I didn't specify how, so I can't take credit for that which I didn't predict.
• GDP will post a 12-month negative number, Depression print. Clean miss.
• The stock market has not bottomed.  1/2 credit.  It had not bottomed but my SPX 500 @ 500 call was not achieved.  The 50% swing, however, got damn close.  Lots of money to be made if you're quick and good, but an absolute minefield if you're a long-term investor - spot on.
• Precious metals will not be a safe haven: Clean miss.  Gold and silver have both performed well.
• The Dollar will not collapse.  Correct.  It hasn't.  It ended the year of 2008 at 82, it now trades at 78, down 5% or so. 
• The pound or Euro - and perhaps both - will be where the FX dislocation initiates if it occurs.  Early, which means wrong.  Clean miss although the last month sure looks bad for the Euro.
• The US Consumer goes from negative savings to positive:  Direct hit.
• Commercial Real Estate will effectively collapse: Direct hit although the effect has been well-hidden.  Several Tickers have been written on this, including major banks walking off 50% underwater properties.  I can't take full credit as the REIT explosion I expected didn't happen, so I only get half a point.
• Along with the above, expect 10% of retail stores to close.  I don't have accurate numbers on this but it sure looks that way.
• Several states will get in serious financial trouble and the default of one or more may occur.  Point.  While the default didn't happen that wasn't a condition of the test, and the list of states in trouble is long and getting longer.
• Mortgages are not done:  No kidding.  Default/delinquency/foreclosure rates continue to skyrocket.  Point.
• If you want to refinance you may get one brief shot with long rates around 4%.  You got two, but I don't lose for multiple points of impact.  Both of those were good opportunities IF your property isn't severely underwater (in which case there is no such thing as a good deal.)
• Those who have said that the corporate bond market is being "unreasonable" will start to look like the jackasses that they are.  Maybe.  Actual defaults did in fact skyrocket but new issues are coming to market and subscribing - even for crap-grade paper.  I can't take a point on this one as my expectation when I wrote it was that issue would go in the toilet.  Miss.
• The calls for "more lending" will go exactly nowhere.  Bingo.
• GM and Chrysler will go bankrupt.  Bingo.
• Protectionism and currency manipulation: Miss, at least in the way I described it.
• Commodities will appear to be headed for a new bull market (falsely): Hit.  Soy, Wheat, etc - all looked to be going parabolic in June.  Now, not so much.  "Beans in the teens" eh?  NOT!
• Sovereign debt defaults will number at least three:  Clean miss.  Greece and a couple of others are on track but didn't happen this year.  No points for "on track."
• China will have its first large-scale rumbling of civil unrest:  Clean miss.  I have to admire how they prevented it - more capacity building into an overcapacity world.  That won't end well but for now they've stove it off.
• Foreign uptake of Treasuries will be choked off - by necessity: Hit.  Almost missed that one, but China has stopped buying as the trade imbalance disappeared.  They have, as expected, turned resources inward.
• The City will get it worse than we are:  Since the test was relative I get credit for it; they're doing things like imposing 90% taxes on banker bonuses.
• Things will get "revolting" in nations: Nope.  Riots and such in Greece don't count - "revolting" meant what it said.

I count 14 "hits" (including half-points) out of 25, for a score of 56%.  That's not so good, especially compared to last year.

Ok, so where did I go wrong?

That's pretty simple: I dramatically underestimated the willingness and ability of "the criminal class" (that would be those in DC and on Wall Street) to lie, cheat, steal, paper over insolvency and get away with it - at least for a while.

Will this ultimately lead to an actual recovery?  No.  It mathematically can't.  A short-term bounce in various metrics, yes, just like an insolvent person can spend on his credit cards until they get cut off and look like they're improving.

The S&P 500 currently stands at roughly 1120.  Most "market callers" are expecting another 20% increase next year, which would put it at 1350, just 15% off the all-time high of 1576 and fairly close to where it finished 2007 - that is, as if 2008 and 2009 never happened.  Lunacy, says I, unless leverage can return to where it was in 2007.

Can it?

No.

Let's remember what happened in 2005 and 2006 that made those things possible.  Investment and commercial banks were stuffing various sorts of securitized paper with garbage loans they knew could not be paid, then selling them off to "investors" (who would later be shown to be bagholders.)  This allowed for an unprecedented expansion in consumer and financial system credit - and that, in turn, allowed the buying of "stuff", whether it was companies playing LBO or you buying a house to flip with an OptionARM.

That was the legacy of the "expansion" in 2005 through 2007, and it is not coming back.

In short this time it really is different, and the proof is right here:

This is the first time since records began at The Fed that credit outstanding has decreased.  I have taken the liberty of breaking down the periods into 10 year chunks, which makes it easier to see:

Pay attention to this last graph, as it is the important one in terms of the 2003-2007 "recovery" - note that we went from ~32 trillion in outstanding debt to $53 trillion at the peak, an expansion of 66%. 

That's how we "recovered" from the tech bust, and to believe that we will "recover" from this one you must either find a way to expand debt by a similar amount - that is, to nearly $90 trillion all-in - or figure out how you will get $35 trillion in spending in the US economy above and beyond what we're doing now over the next three to four years.  In short, we cheated, and to believe we can do it again you must explain how we can cheat once more - and to that degree.

And by the way, for those keeping score - since our monetary system is debt-based declining credit outstanding is the definition of deflation in the monetary sense!

This is exactly what Bernanke said he could avoid.  He was wrong and there is no further room for argument on that point.

Further, I do not believe for a second that the Bernanke's "pulling back" from the monetary playing field has a thing to do with the "stability" of the markets, especially housing.  Specifically, there is no evidence to be found that housing has stabilized or is improving - quite to the contrary.  Treasury's "modification" programs have been a joke, with banks either not following through with their supposed responsibilities and borrowers unable to provide documentation of income and assets (because they didn't have the documentation required at the time of the original loan, and still don't!)  In short all these "programs" are simply an attempt to paper over the Ponzi in residential housing - with little actual success, but lots of smoke, mirrors and lies. 

Madoff got away with the same game for years - produce some false statements and keep soliciting for that new business.  All is well until the cash flow forces disclosure of the fact that you're broke - then the ugly truth, that there is no money as it's all gone - comes out.

Such is happening now.  Servicers have been passing through the interest payments on MBS but principal isn't there to be repaid.  The journal entries are being ignored - for now - because none of this trash is actually trading.  It's all being held at or near "par" (100 cents on the dollar) when in fact many of these securities will be lucky to recover anything at all.  Even the "credit supported" tranches are in trouble - nobody ever believed, especially in the "prime" space, that defaults could reach beyond 2 or 3% and recoveries be under 80 or so.  But they are.  Worse, the HELOCs and "silent seconds" are in fact worth zero where the house is worth less than the first note due to priority of claims - yet most of those are being carried at or near full value.

A big part of the reason for this deterioration is due to "misclassification" of loans.  That is, loans were claimed to be "prime" when they were not - they were either "ALT-A" or worse, Subprime in fact, but stuffed into MBS as "prime paper" and then resold onward.  Fannie and Freddie have been recently fingered as a major part of this, but unlike the author of the recent WSJ Opinion piece I believe this scam went much further than the two GSEs - and there has yet to be any honest examination (say much less prosecution) for this conduct.

There's a rather complex "prisoner's dilemma" going on at the present time, with none of the banks wanting to liquidate either securities or inventory lest they trigger an avalanche.  Yet each is eying the door, fully-aware that the first one through will be the only one who gets through should anyone bolt.  One of the more-interesting identities for the man yelling "FIRE!" could be a lawsuit - or state prosecution - over the myriad misrepresentation in this space during the bubble years.

Last year (2009) there was almost no net debt issuance between corporates and Treasuries, adjusted for Quantitative Easing.  Indeed, it was only about $200 billion.  That this sort of extreme measure was required to prevent a bond market implosion is rather telling.  But what's worse is what's on the calendar for 2010 - nearly $2 trillion of net issue, duration-adjusted.  A huge part of this is Treasury debt, and there the news is even worse, as there's a serious duration problem in this regard - nearly half (about 40%) has a maturity of one year or less.  This means that Treasury must roll over that debt - about $3 trillion worth - "or else."

Ask the asset-backed commercial paper market and auction-rate securities folks what happened to them when their short-duration paper couldn't be rolled on commercially-reasonable terms.  Then extrapolate that to what happens to Treasury if (or possibly when) they're unable to roll $3 trillion plus issue another $2 trillion on top of it to fund the deficit.  Do you really think that $5 trillion and change of Treasury paper is going to be "all ok" sans "monetization" - or will "they" foment an intentionally-engineered stock market crash to scare people into Treasury debt?  I wish Timmy the best of luck with this - he's going to need it.

Remember, the belief that foreigners will not be there to rescue us this time around is not speculation - it in fact is born out by the latest TIC data, which showed that China had bought a net zero in Treasury issue in October.  Nor did anyone else step to the plate.  In short foreign nations are chock full of their own issues and are either issuing debt themselves or need their capital internally.

The equity market loves "liquidity" no matter how it comes, whether the truth is embedded in reports or not.  Nasdaq 1999 anyone?  Those firms were not making money and never would but that didn't stop their stocks from doubling, tripling, and in some cases skyrocketing to 10x their IPO prices. 

The key point is that most of them eventually collapsed and were worth zero, but if you were quick (or lucky) you made a lot of money.  Of course the other side of that ditty is that if you weren't you lost everything.

There are many who claim that valuations are not "extended" or "bubble-like" and point to the disasters of Q3 and Q4 of 2008 as "drags" on the P/E ratio, claiming that one should ignore negative earnings.  This is kinda of like going to the casino and only counting the winning wagers when determining how well you've done.  It may look impressive when you brag to your friends but it won't change the fact that you go home broke, and ignoring negative earnings is part and parcel of the same sort of disease.

The fact of the matter is that if you look to corporate and personal income taxes they have all but collapsed.  These are of course regressive and governments have been handing out various tax breaks to corporations so this may not be a fair indication of business and consumer activity.

However, sales taxes are, if anything, going up in percentage charged - not down - and yet they are also deep in the red in terms of collections by the states.  Since some "necessities" (specifically food in many states) are not taxed this is particular troublesome since this trend points directly toward a collapse in discretionary spending - exactly what we need to power the economy forward.  Then there's China, which reported on the 27th that toy shipments to the US were down 15% year/over/year from 2008 - but we're told that Christmas sales were down "only" 1%.  Riiiiight.

So much for  "economic recovery."

Productivity has been on a tear - and no wonder.  Watching everyone around you get laid off has a way of providing a hell of an incentive to work harder, lest you follow your friends to the unemployment line.

These trends - letting employees go and demanding that your remaining workers do more for the same pay, does provide a lift to profits.  For a while.  But it also destroys the base of consumers you need to buy those products over time, and thus the lift that you enjoy from such downsizing and squeezes is short-lived.  The hangover from that speedball should be hitting in Q1 or Q2 of the coming year, and I expect it to be quite the doozy.

China, on the other hand, has outdone us.  Burdened with far too much capacity they are, of course, building even more!  That would be great except that there's no chance they can absorb the output internally.  Not that they care in the short term, as their definition of "GDP" is different than ours - they count a product when it is produced, not sold.  Gee, why are there all these products lined up unused, from cars to washing machines to - gasp - literal empty CITIES of townhouses and apartments?  How far does that bubble inflate before it blows up?  Hell if I know - the Chinese are not exactly models of transparency so the degree of game-playing they can get away with before someone yells "FIRE!" and runs for the door is more difficult to discern than it is over here. 

In the last few days the Chinese Premier has said that he won't "bow to pressure" to allow the yuan to appreciate.  This of course is code for a weak currency which China desperately wants for its export trade.  Then again, so does Japan, and so does anyone else who exports.  Competitive devaluation sounds quaint, but you're seeing it, and it is likely to continue as an attempt to play "beggar thy neighbor" in the coming year - and beyond.  Playing with explosives these nations are (including our country!)

In the credit arena few lessons seem to have been learned.  CDOs, CDO^2s and other similar loose-pin grenades aren't back - yet - but an awful lot of questionable deals are, including, believe it or not, a couple of PIK/Toggle issues.  Those, for the uninformed, are bonds that allow payment not in money but in more debt!  This sort of "debt pyramiding" is the epitome of stupidity when done by a person and a fairly reliable sign of impending default.  In the corporate world we call it "reaching for yield."  Uh huh.

Many market commentators believe that last year and through March 09 was a "financial panic" similar to 1987, from which the market recovered quickly.  Really?  Go look up the page a bit at the credit chart for the 1980s.  Do you see any contraction in 1987 and 1988 - anywhere?  Nope.  None.  In fact, credit growth continued unabated even though the stock market crashed.  The same occurred in the 2000-2003 time frame (again, look above) during the Tech Implosion.  That's the differentiating factor: This was not a market panic, it was and is a credit lock-up caused by outstanding debt exceeding servicing capacity for several years, where the premise became not paying debt through current income but rather a Ponzi-style pyramid that permitted refinancing and the appearance of solvency only so long as asset prices rose!

This is an event that last occurred in America in the 1920s and it occurred this time for the same reason it did the last time: lax or utterly absent regulation allowed people to foist off trash on people while claiming that it was "money good", just as happened with Florida Swampland in the 1920s.  The entire premise of the so-called "financial innovation" then, as now, was fraud.

The simple fact of the matter is that greed often comes with stupidity and nearly always is shortly followed by disaster.  "Rescued" by governments the "princes of finance" learned nothing, were forced to disgorge nothing, and still walk free among us instead of being either jailed or worse, strung up from a lamp post. 

So far.

Whether the people of the various nations will put up with another trip down the bailout, Quantitative Easing or "stimulus" road is another matter entirely.  Tim Geithner and others have gone too far in their grandstanding, cheerleading and claims of "Armageddon Avoided" - or if you prefer, "Mission Accomplished."  Such claims make for great sound bites but have a habit of slamming the door on future intervention, especially if the need for it appears shortly after the claimed "success."  Remember well that 2010 contains a midterm election in November, and as things stand our new President has seen his approval rating drop faster than a condemned man does through the floor when the handle is pulled.

Then there's the "HAMP", or "mortgage modification" programs generically (there have been several.)  It was claimed that HAMP in particular would prevent 4 million foreclosures by the end of 2009.  It has actually resulted in about a half-million trial modifications, but fewer than 100,000 permanent changes.  This should not surprise - the reason people got in trouble in the first place as that they bought more house than they could reasonably afford on any rational mortgage plan, using schemes such as 1.5 or 2% negative amortization "OptionARMs."  These were not actual mortgages in intent - they were predicated on ever-rising home "values" so that they could be rolled over in a couple of years and amounted to a perpetual below-market rent payment to a bank, collateralized via the speculative bet that prices would continue to rise.  When home prices stopped going up there was literally no way around the inevitable - foreclosure.

Government refuses to recognize this as all the trash paper is literally everywhere around the globe!  What's worse is that the very same banks that were making these bets along with homeowners then extended HELOC and other second-priority lines behind the first, extending the trash brigade even further.

Never mind Geithner's insanity, as displayed here:

GEITHNER: We were very careful from the beginning—but the qualifications get lost—to say that we are going to focus the bulk of the financial force on bringing interest rates and mortgage rates down to cushion the fall in housing prices and help stabilize home values, which will feed into people's basic sense of financial stability.

The reason we got a bubble in the first place was due to excessively-low rates - that is, a cost of borrowing money that did not reflect the fundamental economic realities of repayment and duration risk.

Insanity defined: Doing the same thing over and over but expecting a different result.

There is much hot air blown about how businesses and consumers have "de-levered."  Hogwash.  Again, back to the top graph - we've taken a whole $21 billion off the net credit exposure.  Oh sure, if you remove FedGov from the picture (and you arguably should) it's more like $850 billion - but let's be real here - we're talking about a fifty-three trillion dollar debt. 

Even a trillion is less than a 2% reduction in net leverage!

That's "de-leveraging"?  Like hell.

There is much, much more to go.  To get back to the leverage levels seen in 2000 - which themselves were overheated - we'd have to drop back some twenty five percent, or roughly $13 trillion dollars.

We're less than 10% of the way there, and we were overheated in 2000.

What's a more reasonable leverage level?  How about the "more reasonable" time period between 1951 and say, 1983?  175% of GDP?  That would require we cut the outstanding debt by close to half!

Will we see policies that accomplish that?  Not voluntarily!

On a more-macro (beyond one year) level, let's look at this last-decade debt chart again:

In the beginning of 2000 the total systemic debt outstanding was approximately $25 trillion.  It is now about $53 trillion, or more than double where it was in 2000. Let's look at where we were in various metrics at that time:

• GDP was at $9.7 trillion.  It is now 40% higher, roughly.  (Gee, did we really produce all that with our hands, or did we borrow the money, spend it, and then count that as "GDP growth?")
  
  
• Aggregate GDP over the 2000-2009 years was about $124 trillion; of that, about 20% (25 trillion) was increase in debt over the same period of time. Our so-called "growth" over these years was in fact a chimera in that more than half of it was not real - and that's assuming ZERO interest expense now and forevermore.  Of course interest expense isn't, in fact, zero......
  
  
• The S&P began the year 2000 at 1469.  It now stands at 1126, and that's before inflation adjustment.  The DOW was at 11,500, again, before inflation adjustment, and the Nasdaq 100 was at 3708 (it currently trades 1870.)  Again, all before inflation.  Take 30% off all of today's numbers to adjust for devaluation of the currency's purchasing power (that is, inflation) over the last decade and you're roughly in the ballpark.  The bottom line: you have lost big - more than half if you were in the S&P 500, about 40% in the Dow and a crushing 70% if you were in the Nasdaq 100 over the last ten years.
  
  
• There was no shelter to be found in Real Estate either.  Home prices are back to 2000 levels in many parts of the nation, but a huge number of homes are "underwater" on the profligacy of debt taken on by Americans: about 25% of all loans are underwater nationally and nearly half in Florida.  In 2000 that number was basically zero.
  
  
• There was no net job creation but we went from 282 million to 307 million people in America.  That means 25 million people are unemployed simply due to population growth.  Ain't that grand?
  
  
• Median household (and per-capita) income has actually declined since 2000 adjusted for inflation.  Of course gasoline is more than twice as expensive ($1.26/gal in January of 2000), eggs are more expensive (double, roughly) and such.  Never mind medical insurance and health care - double-digit escalations every year have been the rule rather than the exception with medical insurance costs being up a literal 200% or more over the last ten years.

This little game of Ponzi (faking "GDP" by taking on more and more debt), by the way, is not new.  I present for your edification the following table:

This is the aggregate GDP (that is, all GDP produced) during each decade from 1960 onward, the "DTi" (or debt increment) during that decade - that is, the additional debt outstanding in all sectors during that decade, and the percentage of "GDP" that in fact was NOT from production, but rather was "created" due to raw borrowing.

What we are facing down today is a fifty year Ponzi scheme.  Drill that into your head folks - for fifty years we have created false output gains, with the last 40 of those years having between 15-20% of each year's supposed "GDP" not created by the work of people, but by BORROWING MORE MONEY which will have to be repaid with interest.

This is why we hit the wall in 2007.

To run an increase in GDP of about 5%, as so many "pundits" are claiming we will going forward, we would have to increase the total debt in the system to roughly $90 trillion dollars from the present $53 trillion over the next ten years.

That debt would, of course, need to be serviced.  And nobody in their right mind can possibly believe that government could take on another $37 trillion - when the current oustanding public debt is just seven trillion (that is, government would have to increase its debt by 500%!)

If you take nothing else away from this Year in Review Ticker, it should be that singular chart above and a decent understanding of what it means:

To come back into equilibrium, assuming we do not decrease debt in the system at all, we would have to shrink GDP by about 20%.  But shrinking GDP means that money available to pay down debt would also decrease which would generate even more defaults. 

This is how deflationary depressions happen - years, even decades of playing Ponzi by layering debt upon debt.  Bernanke and Geithner, along with President Obama, are well-aware of these facts which is why they are all pounding the table demanding that banks "loan more." 

The problem with such a prescription is that the wise person won't borrow, for he knows what's coming.  The unwise has no collateral to pledge, and thus can't borrow.

If the government forces (either by persuasion or legislation) lending to those who can't pay they only extend the Ponzi and in doing so make the inevitable collapse WORSE.

We have made no progress economically in terms of the common weal of the average American but have added debt in dramatic amounts to paper over the deficiency.  That's the bottom line on the 2000s, and despite all the crooning that "the economy is on the mend" one has to look at the reality of the common man on the street to see what's coming around the bend for our economy and ask the following question:

How do we get positive economic growth when by every metric available the disposable personal income available to Americans has gone down, personal wealth has in fact decreased when one subtracts out debt (and you must; nobody in their right mind argues that if you go to the bank and take a cash advance for $20,000 on your credit card that you are "more wealthy" as a consequence of having done so!) and while employment at first blush looks "equal" to 2000 in fact there are 25 million more unemployed due to population growth - people who create drag on the economy due to entitlement spending rather than contributing to productive output?

So with all this said, here's what I believe we're looking at for 2010... ready or not, here it comes!

• No, this is not a new Bull Market; the market will be lower on December 31st than it is on January 4th, quite possibly by a a hell of a lot.  We may not break the March 2009 lows - but I also don't believe for a second we're going back to 1576 on the SPX.  Not without the leverage - and we can't get the leverage.  I believe we will end the year down from where we begin on January 1st.  McHugh calls it "Wave 3 Down"; I call it "aw crap."  Either way "irrational exuberance" is back for now but cash flow always wins in the end.  I'll be a "generational buyer" of stocks when dividend yields are over 5% and P/Es are in single digits.  We didn't get there last year and yet those are the historical metrics that mark true Bear Market bottoms.  With that said, I would not be surprised if we hit 1220 on the SPX some time earlier in the year - but it is by no means a lock, contrary to what virtually everyone in the "pundit community" expects (most of which are looking for 1350 or more!)
  
  
• The Long end of the Bond Curve is going to move higher on yields.  We have completed a long-term (multi-year) inverted Head and Shoulders pattern.  The probability of the targets set by that pattern being achieved is extremely high.  The target?  6.9% on the 30 year "long bond" - a rate that puts 30 year mortgage money at least to 7%.  This prediction assumes that we do not get a panic-style sell-off in the Stock Market - if we do get one (and I think it's 50/50 on that) then I withdraw this prediction.
  
  
• House prices will fall another ~20% - whether as a consequence of the rate back-up or utter destruction in the markets generally.  Sorry folks, the housing mess is not over.  The math on this is simple; a $200,000 principal loan at 4.75% for 30 years produces a P&I of $1039.18.  That same payment with a rate of 7% produces a principal financed of $157,107.95.  If, for whatever reason (engineered or not) the stock market collapses then you get your housing price crash anyway.
  
  
• Banks will "give up" on holding their real estate as rates start to backup and will dump their foreclosure inventories.  Why?  Because the regulators may let them to play games with alleged "values" when people can get mortgages at 4%, but at 7% there's just no way the numbers work and the fraud becomes too difficult to countenance.  There are rumors of major banks dumping hundreds of thousands of homes on the market next year - this is likely the backstory on "why."
  
  
• Credit will not ease for "ordinary people."  All the exhortations about "lending more" have been going on now for more than two years yet have gone nowhere.  The jawboning will continue but the results will not come, simply because there is no more good collateral left against which to lend.  This will in turn lead to.
  
  
• A massive second wave of small business bankruptcies will sweep the nation.  We've seen the first part of it.  The second will be worse - far worse.  With long rates backing up and the 30% credit card sweeping the land those who have relied on credit to operate in the small and mid-sized business world will get relentlessly squeezed.  Many will fall.
  
  
• Unemployment will appear to be stabilizing - for a while - but that will prove illusory.  We finish 2010 over 10% - no material improvement.  If things get real bad we might see 12-14%.  Yes, U-3.  I won't stick my neck out that far as a prediction but I believe ending the year at or above 10% is a lock.
  
  
• The "revolting" call for last year was early - but not wrong.  There will be at least one major coup or other violent overthrow of a government in 2010 tied to economic instability - either directly or via a war it spawns.
  
  
• The states will go to the government well for handouts, they will probably get them, but it won't matter.  They'll get some assistance at least, but in the grand scheme of things it doesn't make any difference in a world where long rates are rising precipitously.  California and Arizona are in the biggest trouble, with Michigan, New Jersey and New York right behind.  The public employee unions will have a kitten but again, it won't matter - that which isn't there isn't there, whether you want it to be or not.
  
  
• A "double dip" will be recognized by the end of the year.  Between taxes and rising rates - or an intentionally-detonated stock market to stop the long end of the bond curve going bananas - you can bet on it.
  
  
• China will lose control of their property and plant bubble - with horrible consequences.  They're good at the game, but that which can't go on forever won't.  I bet it blows up before the end of the year.  If so, Australia's property market better watch out - they're levitating on the strength of China's commodity demand and pricing there is California-style. 
  
  
• The Canadian Real Estate Market will show signs of cracking - especially in places like Vancouver.  They may have another year before it all goes to hell, but the time approaches.  Beware.
  
  
• The Fed's games will "leak" and credibility will be shaken severely.  There's too much pressure.  Something will give, somewhere.  Washington DC is too hostile a place for the "hold hands and head for the cliff together" game to work with an election coming up......
  
  
• The Democrats lose big in the House.  Time is probably too short for a viable third party to emerge for the midterm elections, and I don't expect the Democrats to lose House control.  However, I do expect them to lose their filibuster-proof majority in the Senate, and to lose enough seats in The House to trash their "steamroller" approach to legislation.  This might be bullish for the markets late in the year and into 2011 - maybe (divided government is generally good for the markets.)
  
  
• Congress continues to try to spend its way out of the recession - and runs head on into rising rates.  Watch the TBAC reports.  Those will be your "tell" along with the TIC data.
  
  
• One or more of the PIIGS (Portugal, Ireland, Italy, Greece, Spain) either defaults technically or is forced into austerity by the ECB.  Further, Eastern Europe becomes dangerous destabilized.  There is a real possibility of outright hostilities in that part of the world next year.  Let's hope not.  The ECB has a nasty problem on their hands; I have said for quite some time that the Euro is likely to trade at PAR down the road.  This year is probably not the year for it, but the cracks in the dam that ultimately could destroy the European Union should become very apparent in 2010.
  
  
• Contrary to virtually EVERY "investment pundit" on the street today return OF capital will once again assert itself as the primary consideration.  Sentiment indicators as of 12/31, along with 52-week highs, all are at levels that have been associated with tops on a historical basis.  Treasury has to issue $2.5 trillion this year, while we all cheered when they issued $1.5 trillion last year - and got away with it.  China has housing trading at 80x average incomes, Australia and parts of Canada have housing markets at 10x or more average incomes and the banksters and "investors" alike appear to have learned nothing, with "reaching for yield" coming back in force.  Ponzi ponzi ponzi!  Add to this geopolitical event risk and things get interesting.  That which can't continue forever won't - we merely argue over timing, not outcome.  I'll lay the marker on one or more of these timers reaching zero in 2010.

Note: Subject to minor edits/revisions and perhaps an addition or two until the end of January 1st, as usual.

Edit: 1960s DTi had a misplaced divisor - corrected and paragraph referencing "nutty Ponzi" in that decade removed.

I am occasionally stunned when someone who I thought had a good grasp of reality and reason goes entirely off into left field, powered by a thesis that has run out of track.

Mish, unfortunately, has succumbed to this sin in his piece "Fractional Reserve Lending Constitutes Fraud"

He alleges (after waving his arms around):

Fractional Reserve Lending constitutes fraud. The case is irrefutable.

Bluntly: Bullshit.

Let us distinguish between two separate items: Money and Credit.

We shall first define them:

• Money: The product of either growing something, mining something or manufacturing something.  "Money" is actual wealth, and comes into being only through creation.  Ultimately, all money is traced to the only "free lunch" that exists in this solar system, that is, the power of The Sun, although in many cases (e.g. mining) the activity is in fact discovery of previously-created wealth (by the actions of The Sun) levered through human endeavor.

• Credit: The granting of purchasing power predicated upon a future promise to pay with money.

Mish's (and others) claim that "all fractional lending is fraudulent" implies that one cannot pledge money to secure credit.

That's obvious BS; let's put forward a concrete example.

I walk into the forest (grow) and cut down trees (mine) which I then process into lumber (manufacture.)  I dig up some iron ore (mine) and turn it into steel nails (manufacture.)  With these two items I now construct a house (manufacture.)

That house (and all the products that I used to make it) are in fact money.  They were the product of mining, growing, and/or manufacturing.  Each of these acts is in fact the creation of money.

That house, has a representation of money in its utility value.  That is, the shelter value that it has for a group of humans - it provides a place to eat, sleep, take a dump and take shelter from the elements.  That utility value is at its maximum at the point of completion and from that day forward requires further inputs of labor to avoid deterioration; absent that input it will eventually (over many years) crumble into dust.  That is, the house undergoes (as do all things) the natural process of entropy (the process of going from order to disorder.)  We denote that money value in a currency, in this case, "dollars."

Now I have a house, which I pledge as collateral for a loan.  That loan is credit, but that credit is in fact issued against the security of money. 

Borrowing against that house is thus fully secured, not fractionally-reserved, lending.

If you noticed in my previous Ticker I specifically referenced The Monetary Base.  This was not a mistake nor was it an "aside"; it is, in fact crucial to get this definition correct or everything from that point forward will be wrong.  To repeat:

Monetary Base: The monetary base of all credit-based monetary systems is the sum total of all unencumbered assets against which one is both able and willing to borrow.  (No, it is not "M1", "M'" or any such nonsense.)  If you run into a so-called "Economist" who claims to have letters after his name yet makes the argument that "base money" (or any such thing) is the monetary base in a debt-based system find out where he got those letters from and petition them to revoke his degree; he fails at the fundamental skill of logic and deduction, yet it is a near-certainty that he carries proof that his claimed position is wrong in his wallet (a credit card, which spends identically to the dead president it resides next to.)

The "hard money" folks (and many "fiat money" folks) are wrong because they are attached to an ideology that has been subsumed in ALL credit-based monetary systems - an anachronistic ideology that they have elevated to idolatry yet is in fact FALSE.

The ugly part of this willful suspension of mental capacity is that each and every one of these people personally proves the falsity of their foundational premise every single day with their actions in the real economy!  They buy and sell using credit, proving in their personal life the fungible nature of both, yet they reside in a home and drive a car that in fact are money - that is, the product of mining, growing and/or manufacturing.  It takes a profound level of intentional blindness and mental incapacity to refuse to admit that which is shoved in your face literally on a daily basis.

I have repeatedly said that if you start from a false premise every single conclusion you reach from that point forward will be wrong.

The false premise that all of these people adopt and defend against overwhelming proof that they're wrong is that "the monetary base" is some sort of currency, whether fiat or specie. 

This is a false belief in all credit-based monetary systems as it violates the fundamental axiom of what a "base" is - it is that which underlies or underpins what follows.

Yet it is patently obvious that the base upon which a credit-based monetary system rests is in fact the prior productive output of that society - that is, the unencumbered asset base that can be pledged as security for the issue of credit.

Currency is an abstraction; even in a "hard money" world it contains a "promise of conversion" that is in fact a promise, not the conversion itself.  Further, the "hard money" folks define "money" as that which is inexorably linked (e.g. gold and currency convertible into gold on demand) yet they ignore every other output of production as "money" - even though such outputs ARE, in fact, money!

Consider what happens when you adopt a correct view of the monetary base:

• Lending someone $9,000 to buy an $18,000 car (they put the other half down in case) is in fact not a fractional loan.  The lending is in fact fully-secured and thus bears no fractional reserve of any sort.  The same is true when one lends $200,000 to buy a $300,000 house.  The house and the car embody ACTUAL MONEY as both are the fruits of production and thus fully secure the credit issued in such an instance.  Yes, some of their "price" (in dollars) is speculative - but not all, and so long as one does not invade the actual monetary value of these created items no fractional lending has in fact taken place.

• Lending someone $9,000 on a credit card where that loan is 100% backed by excess capital is also not a fractional loan - there is exactly $1 of excess capital (actual money) against every dollar lent out.

Mish and others like him are wrong because they have their premise incorrect.  This incorrect base premise leads to shrill calls for that which will not work (hard currency) and in fact has a thousand-year plus history of not working to stop depressions and other serious economic imbalances.

Yet despite over a thousand years of history none of these people ever examine their premise to discover why these so-called "fixes" never, ever work.  They instead wave their arms and try to come up with all sorts of other "explanations" for things like the Panic of 1873 and the Depression beginning in 1929 instead of examining the foundation of their premise and recognizing it's infirmity.

Idolatry is dangerous in all it's forms, and nowhere is it more dangerous then when so-called writers and pundits fail to recognize that which is sitting right under their face.

There is an old saying that there are two constants in the universe: Death and Taxes.  To that some add a third that seems particularly appropriate in this case: willful blindness, otherwise known as idiocy.