Ticker Classics

Mish "Hard Money" Goes Off The Rails

nospam@example.com (Karl Denninger) — Wed, 07 Oct 2009 15:27:18 -0400

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.

Sound Banking: A Capitalist Imperative

nospam@example.com (Karl Denninger) — Wed, 07 Oct 2009 15:26:35 -0400

It is time to "clear the decks" and talk about exactly what a sound banking system is - and is not.

It is time to identify that which is an exercise in capitalism, and that which is an exercise in fraud.

It is time to strip back the mask of the so-called "moneychangers" and lay bare for all to see exactly what has been going on for the last two decades, and more importantly, to identify whether or not there is a kernel of respectability contained therein.

And finally, it is time to dispense with many of the calls from all corners for "hard money" and the demise of fractional lending as nothing more than an interesting philosophical exercise masquerading as an intentional (or horribly-misguided) misdirection.

Let's first define a few terms; these should be familiar:

Principal: The amount of money you borrow for a given term of time.
Interest: The amount of money you pay, usually expressed as a percentage, to cover three risks and costs - the risk you will not be able to pay the principal, the risk of currency devaluation and the demanded profit on the loan by the lender.
Collateral: The item or items you post with the lender to secure your indebtedness. While "collateral" in the broadest sense includes anything that could be seized after a judgment should you fail to pay (including your labor at subsequent points in time), for the purpose of this discussion we will limit the term "collateral" only to that specific physical, tangible property you post to secure a specific loan, explicitly excluding anything of a speculative nature (such as your ability to earn money in the future.)
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.)

Ok, having settled on definitions, we will now turn to the fundamental reality of fractional reserve banking. Many people claim that banks "create money" or "print money." This is not true; a bank recycles money, that is, it increases the velocity of a given amount of money in circulation, but an ordinary bank (not a Central Bank) never creates new money.

We'll start with our hypothetical bank that has no assets and no deposits, and a 10% fractional reserve requirement. Joe walks in and deposits $10,000 and leaves. The bank now has $10,000 in assets (cash) and $10,000 in liabilities (a book entry that says it owes Joe that $10,000 on his demand.)

Jane now walks in and wants to borrow money to buy a car. She borrows $9,000 from the bank and posts as security the title for the car she purchased. The bank now has exchanged $9,000 of the cash asset that it had for a piece of paper (the title to a car and a promissory note.) Let's, for the sake of argument, agree that Jane paid half cash for the car and that it is worth far more than the $9,000 she borrowed (this becomes important in a minute.)

Now the car dealer comes in and deposits the $9,000 that Jane spent. The books look like this:

	Asset	Liability
Assets	Amount	(Amount)	Liabilities
Cash (from Joe)	$1,000	($10,000)	Joe (Chk Acct)
Promissory/Title (Jane)	$9,000

Cash (Car Dealer)	$9,000	($9,000)	Car Dealer (Chk Acct)

This is where the complaint that the bank is "printing money" comes from; notice that there was only $10,000 in the beginning, but there is now suddenly $19,000 worth of both assets and liabilities.

The "purists" will argue that both the car dealer and Joe can't come in and demand their money - its not there (only $10,000 is, not $19,000.)

This is false: The bank holds a piece of paper worth at least $9,000 and can sell it immediately into the market if necessary. As such it CAN pay both the car dealer and Joe should they both demand their money by disposing of the asset it holds in lieu of the other $9,000 - Jane's loan.

This also looks ok from an accounting perspective - both sides of the ledger balance. Let's keep going.

Steve now comes into the bank and opens a credit card account with a $8,100 credit line. He immediately blows the entire line on an exotic cruise vacation. The cruise line deposits the funds. This is what we've got now (note that the $8,100 he borrowed was 90% of the deposit from the car dealer; I have grouped the transactions to make it simpler to follow.)

	Asset	Liability
Assets	Amount	(Amount)	Liabilities
Cash (from Joe)	$1,000	($10,000)	Joe (Chk Acct)
Promissory/Title (Jane)	$9,000

Cash (Car Dealer)	$900	($9,000)	Car Dealer (Chk Acct)
Credit Card (Steve)	$8,100

Cash (Cruise Line)	$8,100	($8,100)	Cruise Line (Chk Acct)

Now we have a problem. See, the "Credit Card" loan that Steve took out is unsecured. That is, it is nothing more than a raw promise to pay in the future, backed by nothing other than Steve's word, and what's worse, Steve immediately consumed the entire $8,100 - it's gone.

So now if the cruise line, car dealer and Joe all come into the bank and demand their money the bank has a very high probability of not being able to pay. It may be able to sell Steve's paper (the card account) for $8,100, but that line, being unsecured, is likely going to be subject to some sort of haircut in the market - maybe a big one. The particular "haircut" is entirely dependent on the exact state of the economy at any given point in time, along with Steve's personal financial situation.

The important point is that the asset that the bank holds from Steve is nothing more than a signature and promise.

This is unacceptable and in fact is the cause of every economic Depression featuring a deflationary credit collapse over time, as defaults begat more defaults and those defaults, uncovered with capital, cascade through the system instead of being isolated to the failed institution. All of them. 1873, 1929 and the present mess were all caused by systemic and pernicious violation of the most fundamental rule of sound banking: One must never lend out more unsecured than one has in excess capital.

So how could the bank have avoided this? Simple. Let's say that the bank had taken in capital in the form of stock issued to the public; it thus might have a balance sheet that looks like this:

	Asset	Liability
Assets	Amount	(Amount)	Liabilities
Paid In Capital	$10,000	($10,000)	Shareholder Equity

Cash (from Joe)	$1,000	($10,000)	Joe (Chk Acct)
Promissory/Title (Jane)	$9,000

Cash (Car Dealer)	$900	($9,000)	Car Dealer (Chk Acct)
Credit Card (Steve)	$8,100

Cash (Cruise Line)	$8,100	($8,100)	Cruise Line (Chk Acct)

Now everything is fine. Why? Because the shareholder equity can get whacked as required. Let's assume Steve defaults; we now have:

	Asset	Liability
Assets	Amount	(Amount)	Liabilities
Paid In Capital	$10,000	($1,900)	Shareholder Equity

Cash (from Joe)	$1,000	($10,000)	Joe (Chk Acct)
Promissory/Title (Jane)	$9,000

Cash (Car Dealer)	$900	($9,000)	Car Dealer (Chk Acct)
Credit Card (Steve)	$8,100	($8,100)	Defaulted (Steve)

Cash (Cruise Line)	$8,100	($8,100)	Cruise Line (Chk Acct)

Assets and Liabilites	$37,100	($37,100)

Notice that the books balance, but the loss was taken out of the shareholder's hide.

"Paid in Capital" is one of several types of "excess capital" that a bank can hold. A bank could also issue bonds and it can retain earnings; all three are actual hard cash.

Therefore, the fundamental rule is this:

No bank may be permitted, under any circumstances, to have outstanding more in unsecured lending than it has in actual excess capital.

So long as this rule is adhered to there is never a risk of depositor loss and "deposit insurance" such as the FDIC is irrelevant. Indeed, the FDIC should exist only to cover the malfeasance of government officials who have failed in their essential task - that is, guaranteeing that the banks under its supervision never exceed their excess capital in unsecured lending.

The counter-argument - that one cannot quantify asset prices accurately and thus incursion of this rule will occur "accidentally" - is often raised. This is a chimera - the standard is that it may never happen, and it is the responsibility of bank management to decide how close they want to fly to the Sun! That is, the more leverage they take on, the lower the down payments they permit for their asset-based lending and the closer they run in today's market prices for the assets they hold to their excess capital the greater the risk that an economic dislocation of some sort will render them instantly insolvent and closed, wiping out the entirety of their unsecured bond and stockholders.

In point of fact any bank which has outstanding more in unsecured lending than it has in excess capital is at that moment insolvent, in that it has no security against the amount outstanding in loans that exceed excess capital.

Note that this has exactly nothing to do with whether you are on a Gold Standard nor does it have anything to do with fractional reserve lending. In fact the Depressions of both 1873 and the 1929/1930s occurred while on "hard money". A gold standard (or any other "hard" currency) will do nothing to stop this, because the problem has never been the fiat nature of currency - it is the fact that credit is being extended without collateral beyond the actual cash reserves of the institution in question.

Now here's the nasty: It is illegal in many states for a bank to accept a deposit while in this condition. As just one of many examples (Nevada):

1. It is unlawful for a president, director, manager, cashier or other officer or employee of any bank to permit the bank to remain open for business, or to assent to the reception of deposits or the creation of debts by the banking institution, after he has knowledge of the fact that it is insolvent or in failing circumstances. An officer, director, manager or agent of a bank shall examine the affairs of the bank and shall know its condition. Upon the failure of any such person to discharge his duty of examination, he must be held, for the purpose of this title, to have had knowledge of the insolvency of the bank, or that it was in failing circumstances, and shall be deemed to have assented to the receipt of deposits while the bank was insolvent or in failing circumstances. A person who violates the provisions of this subsection is individually responsible for deposits so received, and all such debts so contracted, but any director who has paid more than his share of such liabilities has a remedy at law against other persons who have not paid their full share of such liabilities for contribution.

....

3. A person who violates the provisions of this section, or who is an accessory to, or permits or connives at, the receiving or accepting of any such deposits, or the giving of such preferences, is guilty of a category D felony and shall be punished as provided in NRS 193.130.

Each and every bank officer and manager is not only civilly liable for any loss suffered (e.g. balances beyond insured limits) but is also CRIMINALLY liable for the acceptance of deposits while the bank they work for is factually insolvent in many of these states, including Nevada.

If The Federal Government will not close these institutions and will not act in this fashion then we must insist that the STATES do so in accordance with their legal code.

These laws exist for a simple reason: When you walk into a bank and deposit money you have a contractual understanding that it will be returned to you either immediately on demand or in a relatively short period of time (effectively on demand.) This is even true for so-called "time deposits"; you will forfeit some amount of interest (sometimes all of it!) but if you cash a CD early they are still required to hand over your money.

If the bank does not have it nor can they raise it immediately as a consequence of lending out money unsecured in amounts that exceed their excess capital then they have committed the common-law crime of fraud; they have induced you to lend them money with a promise to repay that they know is entirely speculative in terms of their capacity to perform. Unless that is disclosed to you before you tender your funds to them they have committed fraud by concealing the speculative nature of their ability to return your funds on demand. It is that simple and a number of states recognize this as a formal section of their legal code.

IF THE FEDERAL GOVERNMENT WILL NOT DO ITS JOB THEN IT IS TIME FOR WE THE PEOPLE TO DEMAND THAT THE STATE GOVERNMENTS DO SO FOR THEM!

The Economic Tsunami Is Curling Over

nospam@example.com (Karl Denninger) — Mon, 11 May 2009 12:51:20 -0400

I have only one question for those who speak of "green shoots":

What are you smoking?

Let's start with a really ugly report from The Nelson A. Rockefeller Institute of Government:

The trend in state and local tax collections has been clearly downward from 2005 growth that was unusually high, and 2006 growth rates that were more in line with historical averages. Figure 1 shows the four-quarter moving average of year-over-year growth in state tax collections and local tax collections, after adjusting for inflation. Year-over-year change in state taxes, adjusted for inflation, has averaged negative 1.1 percent over the last four quarters, down from the 1.4 percent average growth of a year ago and 3.4 percent of two years ago.

There are a number of graphs in that paper, one of which shows that right around January (the latest for which they have complete data) there is an uptick in Goods consumption. This is part of where the Kudlow "green shoot" brigade is getting their information from.

However, if you look at the graph, you will see that every year there is a similar tick upward in consumption, although the exact date of it does vary by a month or two.

Why?

It's called Christmas!

State Sales Tax Revenues tell the story. California is absolutely cratering, for example:

Sales taxes were $452 million lower (-50.9%) than last April, and personal income taxes were down $5.7 billion (-43.6%).

Fifty percent?! FIFTY?

California is responsible for thirteen percent of the total US GDP and if it were an independent nation it would be the tenth largest economy in the world.

The idea that we can have some sort of economic recovery while the sales tax receipts - which are a direct measurement of consumer activity - are down by half is pure insanity. Where is the economic activity that is going to create this "recovery"?

And let me remind everyone - sales tax receipts are not a lagging indicator, they tell you what is going on right now.

Now let's look at job losses in this recession compared to others. As written up in the NY Times:

A bottom? Where?

To be fair employment is a lagging indicator; there is no pickup in hiring for some time after the economy truly bottoms, usually about 6-9 months. The reason is that people are both slow to fire (they're nice) and slow to hire (they're not convinced the recovery will "take") and as such there is a lag in both the firings when things slow down and the hirings when things begin to recover.

Nonetheless, there is nothing to suggest that we're anywhere near the bottom of this cycle. Indeed, we've been setting records for the severity and duration of losses in the postwar era, surpassing the 81-83 duration and vastly surpassing all of the previous recessions in terms of depth.

Nor are the "programs" trotted out by Obama (and his predecessor, to be fair) doing anything. We recently learned that "Hope for Homeowners" made a grand total of..... wait for it..... 51 loans.

FIFTY ONE? No, that is not a misprint:

Senior federal housing officials say that of 51 loans made under the program, 50 were made by Melville, N.Y.-based Lend America, and those 50 loans are being held up pending ongoing federal investigations. The officials, who insisted on anonymity because they are not authorized to speak on the matter, declined to offer specifics except to say anything from inadequate documentation to unethical practices could be the focus of the queries.

Remember, "Hope for Homeowners" was supposed to help four hundred thousand people stay in their homes.

The net closed loan count is fifty one over a period of six months.

Oh, and the reason for that article? The company responsible for 50 of the 51 loans is under investigation by The Department of Justice!

I would like to be optimistic on the economy and thus, the capital markets.

I refuse, however, to countenance and cheerlead for fraudulent "reporting" and false claims in the media in an attempt to prop up asset prices so that banks can issue stock into an overheated bubble market created through lies.

In my opinion, that is exactly what is going on here, and is an extension of the game-playing that occurred with the so-called "stress tests", as reported in the WSJ over the weekend:

The Federal Reserve significantly scaled back the size of the capital hole facing some of the nation's biggest banks shortly before concluding its stress tests, following two weeks of intense bargaining.

In addition, according to bank and government officials, the Fed used a different measurement of bank-capital levels than analysts and investors had been expecting, resulting in much smaller capital deficits.

....

The Fed's findings were less severe than some experts had been bracing for. A weeklong rally in bank stocks continued Friday, with the KBW Bank Stocks index surging 10%. Investors were especially relieved by the relatively small capital holes at regional banks. Shares of Fifth Third soared 59%, while Regions Financial Corp.'s $2.5 billion deficit led to a 25% leap in its stock.

Right.

The original numbers weren't what the banks wanted to hear, so they complained and got them changed. Investors were duped by this lack of disclosure of the exact nature and difference in the figures, and besides, the banks came up with the asset valuations anyway - there was apparently no independent verification.

Some of the changes were truly massive - Citibank, for example, managed to wheedle down $35 billion to $5.5, and Bank of America managed to wheedle down their $50 billion number to $33.9. Fifth Third's original number was $2.6 billion; the reported number $1.1.

Is it thus a "green shoot" that the results were "better" than investors expected? No. The results were in fact at least as bad as expected, and maybe worse. But when the banks didn't like the results they whined and managed to get the teacher to change the grade - ex-post-facto.

Finally, we have Bernanke. I have opined several times over the last couple of weeks that his "Quantitative Easing" is an abject failure. I said when it was announced that it would not work, and it hasn't worked.

Blackrock is prodding Ben to increase the buyback:

May 11 (Bloomberg) -- The world’s biggest investors are increasing bets that Federal Reserve Chairman Ben S. Bernanke will boost purchases of Treasuries as the steepest losses on government debt since 1994 send mortgage rates above 5 percent.

What I find disturbing is that through this entire crisis, as I have outlined repeatedly, neither The Fed or Treasury seems to understand the first damn thing about trading.

Simply put when you prop up prices beyond where they should be everyone who owns that thing will sell into you. The paradox is that this selling then causes prices to fall, not rise - that is, your intended move not only doesn't happen the reverse of the intended move does!

This happened with Fannie and Freddie (Paulson's infamous "Bazooka") and now it is happening in the credit market with Treasury Debt.

If Bernanke does not back off he will find himself in a tightening monetary flat spin. As he comes to own more and more of the public float of the long end the impact of each sale into his program by private holders is magnified in the market.

That is, if there is $1 trillion of something outstanding and you buy $100 billion of it (10% of the float) the impact is X. If there is now $900 billion outstanding (after the first operation) and you buy another $100 billion you have in fact sucked up about 11%. When you get to owning $500 billion another $100 billion sucks up 20% of the float. Each tender operation of the same size thus creates an ever-increasing impact on the underlying price, and since nobody in their right mind will continue to hold something they believe is overvalued, the spiral will tighten precipitously, forcing even more purchases until The Fed owns it all.

At or before that point the long end becomes unavailable to Treasury as a funding source. Forcing all the issue to the short end now starts to ramp short yields (supply and demand, remember - add massive supply and what happens to price?) and Bernanke will then be urged to buy down the time line.

This path leads to a singularity - and both monetary and political failure. The bad news is that the event horizon is far before Bernanke actually winds up owning the entire float, but nobody knows exactly where it is.

Yet once crossed, there is no escape from the outcome.

We best not go there, because if we go down that road too far Americans will be needing all those firearms that they've been buying since Obama was elected - not for a revolution, as some suppose, but rather for self-defense as our political, social and economic structures collapse.

Mr. President, Open The Other Eye!

nospam@example.com (Karl Denninger) — Tue, 14 Apr 2009 12:59:00 -0400

Today President Obama delivered a speech that, on balance, was far better than many we have heard before on the economy and markets:

This recession was not caused by a normal downturn in the business cycle. It was caused by a perfect storm of irresponsibility and poor decision-making that stretched from Wall Street to Washington to Main Street.

Right. Now let's keep going a bit:

And credit agencies that are supposed to help investors determine the soundness of various investments stamped the securities with their safest rating when they should have been labeled "Buyer Beware."

That's called fraud Mr. President.

No one really knew what the actual value of these securities were, but since the housing market was booming and prices were rising, banks and investors kept buying and selling them, always passing off the risk to someone else for a greater profit without having to take any of the responsibility. Banks took on more debt than they could handle. The government-chartered companies Fannie Mae and Freddie Mac, whose traditional mandate was to help support traditional mortgages, decided to get in on the action by buying and holding billions of dollars of these securities. AIG, the biggest insurer in the world, decided to make profits by selling billions of dollars of complicated financial instruments that supposedly insured these securities. Everybody was making record profits - except the wealth created was real only on paper. And as the bubble grew, there was almost no accountability or oversight from anyone in Washington.

That's called FRAUD too Mr. President.

This is the situation we confronted on the day we took office. And so our most urgent task has been to clear away the wreckage, repair the immediate damage to the economy, and do everything we can to prevent a larger collapse. And since the problems we face are all working off each other to feed a vicious economic downturn, we've had no choice but to attack all fronts of our economic crisis at once.

On the contrary. You still have not taken the first step in addressing the problem, which is to call a thing what it is.

Those who flim-flammed investors, homeowners, debt buyers and others, no matter whether they were bankers, regulators, government agencies or others, committed fraud. They were well-aware of the fact that there was no investigation of credit quality or underwriting being performed but they did not care and stamped these securities and loans as "money good" when there was absolutely no basis in fact, law, or even reasonable belief for making such a claim.

Of course, there are some who argue that the government should stand back and simply let these banks fail - especially since in many cases it was their bad decisions that helped create the crisis in the first place.

I argue that fraud must not be rewarded. We need a banking system but we do not need the specific banks that were involved in this mess. Not all banks were. Some were, some were not. Those who were should be punished, not rewarded. Those investors who bought these securities believing they were "money good" but were fools should lose money. Those who were duped should sue and for those who committed an act identified in the law as a crime should be prosecuted.

Instead, your administration and the one previous both have decided to continue and promulgate policies that have amounted to looting of the Treasury and The American People.

This is also why we're moving aggressively to unfreeze markets and jumpstart lending outside the banking system, where more than half of all lending in America actually takes place.

You CAN'T succeed in this goal - at least not if the real, underlying goal is to bring long-term prosperity to America.

The debt in the system is too high and the marginal utility of new dollars of debt is exceedingly low - and may in fact be negative.

The math is never wrong and once the marginal GDP contribution of a new dollar of debt goes negative you enter a mathematically-certain circumstance where further forced borrowing and lending, whether by government or private enterprise puts the entire economy at grave risk of all-on collapse.

That "event horizon" is dangerously close and may have been crossed. An exact measurement of this point, and determination of where it lies, is not possible. However, we know for a fact that a new dollar of debt has generated as little as ten cents worth of GDP as recently as the last year - and this was before you committed to pump nearly $2 trillion of new debt into the economy with your current budget.

I would like to see the Government try to "prop up" the economy with new spending and temporary deficits. That would be a nice idea - if we could afford it and if the mathematics suggested that it would work.

Sadly the mathematics suggest exactly the opposite - that such a policy as you have adopted will bring extremely short-lived and fleeting "benefits", if it brings any benefit at all, and runs the severe and immediate risk of pushing the "contribution to GDP per dollar of debt" value into negative territory.

I understand the argument that we "must invest for the future."

That argument is true, standing alone.

The problem, Mr. President, is that we have squandered the ability to make that investment in the present tense, and until we force the bad debt out of the system, thereby clearing the ability for new debt to contribute to GDP instead of sink it, your program cannot succeed and bring forth the benefits you seek.

Reforming Medicare, Medicaid and Social Security must happen. But these threats are not "debts" as are the remainder of indebtedness in the economy - they are structural deficits that exist as a result of promises.

There is a tremendous difference between a promise and a debt. One has no force of law - the other does. One can be addressed through legislation - the other cannot, it can only be paid down or defaulted.

I applaud your efforts to resolve the structural issues surrounding entitlement programs. It needed to happen 20 years ago, 10 years ago, and it still must happen today. To the extent these are more than simple words, as every President in the last 20 years has mouthed, I applaud the effort and wholeheartedly support making these programs sustainable over the long term - something that was never part of their original intent or planning.

But this is orthogonal to the issues surrounding our economy in the present tense, which are bounded by actual debts, not political promises.

America must live within its means on a personal, corporate and government level. We must have manufacturing in this nation and put a stop to global wage arbitrage that results in abusive conditions for workers and unsustainable international trade imbalances.

America must not allow those who defrauded to profit, and those who were defrauded must have their day in court. Excessive debt in all parts of the economy must either be paid down or defaulted, with the latter serving as the proper and just result for a lender who makes an unsound loan, no matter whether that "lender" is someone who bought a bond or a bank that made "fog a mirror" mortgages.

The ratio of Debt to GDP must come down to sustainable levels so that the contribution that debt makes to GDP rises, avoiding the disastrous circumstance where a new dollar of debt creates a negative impact on GDP.

This means difficult choices must be faced and made in this nation and part of that foundation must be the clearing of unsustainable debt through default.

Simply put, we must avoid the event horizon of a negative GDP contribution from new debt. Should that "event horizon" be crossed we will enter an economic state where incredibly-severe economic contraction worse than the 1930s will become inevitable as further attempts to issue debt will result in an acceleration of defaults and further depression of GDP.

The laws of mathematics are not suggestions, and your advisers, along with those on both sides of the aisle with political aspirations and positions, have a tremendous vested interest in refusing to admit that their plans and policies of the last 20 years were mathematically unsound and over the longer term must inevitably lead to economic collapse.

Do not be the fool Mr. President; ask your "advisers" and those in your cabinet the following questions:

For each dollar of debt that is taken on, what delta occurs to GDP? Show your work and document it.
What has been the trend in this number over the previous fifty years? Has there been any interruption in that trend?
What happens IF that number becomes negative?
Can you prove that we are not either in that situation now, or that the course we are currently on will not result in that number becoming negative?

Think Mr. President. You're highly-intelligent, and I'm quite certain you understand mathematics at this level - no complex understanding of Calculus or differential equations is necessary.

For your advisers' (and your) benefit I am including the chart I first published many months ago (in October of last year) showing the danger you face.

Don't blow it Mr. President; there are no "do-overs" once the "zero point" is exceeded.

April 1st Roundup: GM And More

nospam@example.com (Karl Denninger) — Wed, 01 Apr 2009 10:34:42 -0400

CNBC has come up with a new word: "Great Recession".

Nobody, of course, wants to use the "D" word, but the "D" word is exactly what we should be using, because its what we're entering - and in fact are likely already in.

All the commentators like to talk about "monetary policy" and how it "isn't working because the credit markets are dysfunctional."

Nobody mentions that the reason the credit markets are dysfunctional is that credit has been abused by consumers, industry and government alike.

1/3rd of all homes now have mortgages that exceed the value of the house. This didn't happen by accident, it happened due to the collapse in traditional underwriting standards, which once again are:

20% down payment, in saved cash (not additional credit)
28% maximum "front end" ratio, that is, the entirety of your housing expenses to gross income
36% "back end" ratio maximum, that is, the entirety of your debt service, including housing and all other debt service such as credit cards and car payments + student loans, to gross income.

Nobody wants to go back to reasonable lending standards. Why? Because if you do, you exclude most buyers - not because of the housing price or the "front end" ratio, but because consumers have levered up everywhere else too, including student loans, credit cards and buying a new car every three years.

The hue and cry for such silliness as seller-financed down-payment "assistance" (which ought to be outlawed as intentionally misleading, as it serves to improperly prop up the reported sale price of the house, effectively "laundering" a seller concession) FHA 3.5% "down payments" (1/5th the reasonable requirement) along with other expressions of idiocy such as allowing AUS/TOTAL automated approvals that stretch debt-to-income ratios is proof positive that we're a nation that is stuck in debt up to our necks.

There is no durable and reasonable recovery that can happen until that debt is either paid down or defaulted. Since we continue to refuse to tighten up standards for major capital purchases (including houses and cars) we will continue to march over the cliff, one step at a time, until the transfer of the defaulting and to-be-defaulted debt is transferred to a "government guarantee" reaches a critical mass.

At that point government funding evaporates from external sources and the "job cuts" all happen there, along with forced cuts in government largess programs - whether the administration wants them to or not.

President Obama and Congress simply refuse to deal with reality and his so-called "advisers" are in fact up to their necks in the policies that got us here. As a consequence people like Larry Summers cannot be counted on to provide impartial or even honest analysis, as it is their very policy structures and suggestions from more than ten years ago that got us here in the first place!

Obama is now said to be favoring a "prepackaged" bankruptcy for GM, allowing Chrysler to go under. It would be nice if we would see our President realize that this same mess exists in virtually every corner of our economy, but doing that requires skewering people who he considers "trusted advisers."

It is rather amusing to hear Senators like Mr. Shelby come out and tell us how bankruptcy is "best for the taxpayer" when it comes to GM (true) but they won't say the same thing about Bank America and Citibank. Why not? Fact is, a bankruptcy is the correct solution to too much debt and excess capacity no matter where it is, as it is the formal structure under our capitalist system by which excessive debt (supporting capacity that is in excess of requirements and thus unproductive) is cleared through debt-to-equity cramdowns, real concessions by all stakeholders (forced by a judge) and/or outright defaults.

These same Congressfolk also don't want to repeal the so-called "bankruptcy reform" law of a few years ago that made it nearly-impossible for income-earning Americans to discharge their debts over that same Constitutionally-provided process. Indeed over the years Congress has extended the net of "impossible to discharge" debt ever further like a creeping prickerbush; child support awards, IRS debt and privately-written student loans. More recently for those with above-median incomes all debt became effectively non-dischargable.

Never mind that these very same bankers have effectively secured themselves a pass from prosecution for outright fraud - which they then committed with wild abandon, embezzling trillions in total from citizens, municipalities and pension funds around the world, squirreling it away for their own benefit while chortling at their "bought and paid for" immunity from prosecution thinly disguised as "campaign contributions."

This of course is what the bankers want, but it is precisely backward in relationship to what America needs. If we are to see our debt levels contract from 370% of GDP (up from 350% last year) and not provoke a GDP collapse (which will rocket that ratio higher) we must instead:

Reverse the "bankruptcy reform" act.
Repeal all restrictions on debt that can be discharged in bankruptcy.
Force all firms and individuals who are unable to pay through bankruptcy.

In short the solution to insoluble debt is bankruptcy. It is through bankruptcy that we clear that debt from the books, which is a necessary precondition to a re-balancing of the economic output of this nation to its ability to fund consumption with production, not "pulled forward" credit-driven false demand.

The UAW and organized labor in general, long thought to be the "favored" among President Obama and the Democrats through their speeches and claims, in fact were thrown under the bus. It is simply remarkable that the UAW hasn't literally mobilized every labor union in the United States and coalesced their memberships into a march on Washington DC, laying (peaceful!) siege to the city and demanding that the same sort of "tough love" meted out for GM and Chrysler be applied to all the financial concerns that have instead received well north of a trillion dollars of largess, forcing the rescission of all previously-allocated "bailouts" and refusing to leave until a level playing field is achieved. One must wonder if Gettlefinger and the union "brothers" really are brothers at all, or whether the last 20 years has made them, once the most-feared political constituency in America, yet another neutered political has-been incapable of anything beyond a bad parody of carnival barking.

Real economic growth and the stabilization of the job base, along with normalization of the credit markets will not and in fact cannot happen until this takes place.

We must as a nation choose - we can either choose a continued descent into chaos that literally threatens our way of life and political system, or we can choose to force those who made bad bets, whether they be improperly-underwritten loans, naked CDS written without capital or those who speculated in the purchase of their house to go through the bankruptcy process and thus remove from the system insoluble debt via the process of bankruptcy and default.

The latter choice is politically unpalatable but it beats the loss of social order, the collapse of our economy and credit markets and ultimately the collapse in government funding that can (and will, if allowed to descend to that level) result in the loss of our government and way of life.

The Singular Problem With Credit

nospam@example.com (Karl Denninger) — Wed, 25 Feb 2009 13:38:04 -0500

I keep getting "pushback" from people in the mortgage industry and elsewhere, especially related to my Youtube Videos, with all sorts of claims that "we can't go after all the fraud in the mortgage business - get over it", along with similar missives.

Folks, you need to understand something very clearly, because Bernnake and the rest of the policymakers have laid out the truth for you - if you care to listen.

Fully 2/3rds of credit provided in our economic system is non-bank lending.

That is, it is hedge funds, sovereign wealth funds, pension funds, insurance companies and both foreign and domestic private investors who have extra capital they do not need at the moment, and they are willing to lend that money into the economy.

These are the buyers of securitized debt instruments.

This market is closed.

Both ASF (American Securitization Forum) and Federal Reserve statistics say that there has been essentially no securitized debt issuance over the last six months.

None.

That market is closed because this class of investors was gang raped by the pernicious and outrageous fraud up and down the line within the market.

Arguing over whether the banks are responsible for not verifying information provided (they are), automated approvals are responsible (they are), ratings agencies are responsible for being essentially purchased rubber stamps (they are) or borrowers who fraudulently overstated income and understated debt (they are) misses the point.

The point is that all of these factors are in fact elements of fraud.

All of these are willful and knowing misrepresentation - either by omission or commission - of the risks and true credit profile of the collateral, borrower's character and capacity, market assumptions used in modeling or all of the above.

The fact of the matter is that this 2/3rds of the credit provided to our market has left and is not coming back until the misrepresentation ends and they can be assured that it will not happen again.

That is, these people are demanding their pound of flesh using the most powerful weapon they have - their checkbook.

As just one of many examples:

Feb. 20 (Bloomberg) -- Asian investors won’t buy debt and mortgage-backed securities from Fannie Mae and Freddie Mac until they carry explicit U.S. guarantees, similar to those given on bonds issued by Bank of America Corp. or Citigroup Inc.

And why should they?

These investors got boned. Repeatedly. In the non-agency market they didn't just get boned they got gang-raped, with losses in some cases on CDOs and similar being 100%.

These events are not supposed to happen, according to risk modeling. And if the risk model actually had put into it the quality of underwriting (none), the verification of income and assets (none), a realistic model of credit growth and asset prices (ha!) and similar, it wouldn't have - because there would have been no competitive market for those securities at the prices asked.

The argument that this was all "the bank's fault" is simply not true. The blame is spread across the curve - the fact that your local bank has no guard does not give license to someone that desires to come in and rob it; in that case we penalize the bank but we still lock up the bank robber.

But all of this belies the underlying problem: in the attempt to divert attention from one group or another - and all of the guilty parties are engaged in it at this point, including Congress and our other regulatory agencies such as The Fed - we are forgetting that the private capital is still gone and until we find a way to guarantee that another assault will not happen that capital will not return.

As I listen to Bernanke's testimony in front of both the House and Senate, and as I watched President Obama's speech last night, I remain stunned by the lack of recognition of the above facts.

While lawmakers and policymakers such as Bernanke continue to blame "understaffing" (code in DC for "we want more money") and the lack of fully-formed plans, the fact remains that unless private capital can be convinced to return, and soon, we are headed for an economic depression worse than the 1930s.

This is not some manner of conjecture or fear-mongering - it is a fact that there is absolutely no way we can maintain our standard of living or economic output at anywhere near former levels with 2/3rds of credit capacity gone, nor can we replace that 2/3rds of the former capacity via other means.

To put this in perspective we are talking about a $50 trillion (roughly) credit universe for the United States; 2/3rds of that is ~$30 trillion dollars. It is simply not possible for the government or Fed to replace this, which is why even with a commitment of $9 trillion as has been made thus far the economy is not responding; 2/3rds of what disappeared is still gone and yet trying to actually fund $9 trillion through T-bond sales would cause an immediate implosion in the Treasury market.

We therefore have two choices, and if we do not pick #1 we will get #2:

Stop "the bezzle" - right here and now - punishing the fraudsters across the board and clamping down on all manner of fraud in the future with enforcement of the law both looking back and forward being the primary driver of policy.
Accept that we will have an economic Depression worse than the 1930s, as the continued absence of private credit provision will guarantee a contraction in GDP of at least 30%. This will result in the bankruptcy of about 20% of the S&P 500, 25-30% unemployment, half of all private businesses in the United States going under and general economic malaise at least equivalent to the 1930s and quite possibly far worse.

Those are the only choices ladies and gentlemen. All the handwaving in the world will not convince private capital to come back and you cannot force that private capital to return.

We can only convince private capital to return by guaranteeing that the rule of law will be upheld, that those who screwed them this time will be punished in accordance with the law and that anyone who attempts to screw them in the future will be immediately dealt with under the same provisions.

Those are the choices folks, and if we do not accept this and adopt it as policy within a very short period of time the economic contraction will continue and, once it reaches a critical point, the collapse in the equity and credit markets will accelerate and be impossible to stop until liquidation has run its course.

We are very close to reaching that tipping point and the reaction today in the markets, after being filled with "hope" yesterday, is a direct consequence of the administration's failure to follow through with concrete steps to restore trust, transparency, and the rule of law.

Until and unless you hear that message come out of Washington DC your wisest course of action is to be prepared for economic conditions at least as bad as those during the 1930s, because unless policy changes that is exactly what we are going to get.

The math is never wrong.

On Our Fraudulent Economy

nospam@example.com (Karl Denninger) — Fri, 20 Feb 2009 11:14:26 -0500

This morning Rick Santelli went nuclear on the entire "fraudulent mortgage" game - the culmination of a series of rants that he has (correctly) launched over the last year.

(As an aside, great minds must think alike, as we both had the "extra bathroom" thing in our morning rants!)

You can view it here (can't embed as its a CNBS video clip)

Here's the point folks, when you get down to it:

The entire last two decades of so-called "Economic Growth" has been fueled by one fraud after another, starting with the Internet Bubble.
This fraud has been systematic and the mainstream media has been both an implicit and explicit enabler of these frauds, instead of doing its job, which is to root them out. The looks on the faces of the other CNBC "anchors" was one of abject fear - perhaps parts of "The Fourth Estate" is coming to realize that when the pitchforks and torches come out - and they certainly will if we hold the course we're on - they might have some trouble explaining why they shouldn't be near the head of the list of those being "sought"?
The conflicts of interest in the media, where their advertising dollars come from those who are promulgating and profiting from these frauds means that they must choose between their job of protecting the public (their essential purpose under The First Amendment) and being a willing accomplice in the theft being performed by the prime actors in these frauds.
With the exception of a few months around 1995 (which roughly coincided with Microsoft's release of Win/95, the first "consumer" system of wide acceptance that had a dialer built in along with a web browser) the Internet NEVER doubled in size every three months. Yet this was paraded as the statistic to justify all the bubble companies up until the bubble burst in the spring of 2000. I was one of hundreds if not thousands of people with access to the core of the network and KNEW this was a lie. Nobody would report the truth. Proof? Read all about it:
- And that's not the only thing Denninger feels strongly about. Though the Internet made him a millionaire -- his stake in MCS was rumoured to be worth US$12 million at the time of the company's sale -- the feisty Midwesterner has nothing but scorn for the industry overall.
  
  "I refused to take any stake in the acquiring firm. The shell game being played by these corporations is astounding," he said.
  
  Denninger has also steadfastly avoided investing any of his personal fortune in the Internet: "I refuse to have anything to do with the Nasdaq 100. There will be a shake-out, and when it comes, it will be ugly and it will happen fast."
  
  He might as well have been speaking of Black Week, April 10 through April 14, when the Nasdaq crashed.
  
  The volatility of Net stocks in the past few weeks makes Denninger seem prescient, but his dislike for the unseemly marriage of breathless hype and dubious business plans is visceral.
When the Internet bubble collapsed it was decided to intentionally pump liquidity into the system and ignore both banking regulations and the law, making possible the housing bubble.
When the leverage ran out Henry Paulson, who was then with Goldman Sachs, came to Congress and the SEC and asked for the ability to run what would turn into effective infinite leverage. The request was granted.
The very same Henry Paulson, having done this, then bailed off and became The Secretary of the Treasury. He was fully aware of what was going on when the bubble started to come apart in 2007 because he personally lobbied for the changes in law that made the terminal blow off possible!
Every single one of the firms that has blown up has had leverage far higher than the former 14:1 legal limit. Fannie Mae, Freddie Mac, AIG, Bear Stearns and Lehman - all had leverage at least twice the former legal limit when they blew up. After the first blowup Treasury and the SEC could have slammed the door on this and forced leverage to be taken back down - in August of 2007. Government intentionally refused to take that action despite myself and others screaming about it.
Hundreds of billions of dollars were siphoned off by the banksters and common Americans as a consequence of willfully-blind and even fraudulent "lending."

If you measure "prosperity" by stock prices we're somewhere back in 1997 or 1998. But if the entirety of these two bubbles were fraud-driven (and they were) then a realistic expectation is that we will not only return to 1995 stock prices (about ~450 on the S&P 500) but we will over-correct significantly because the debt that this fraud created still remains in the economy!

That could easily cut the S&P in half again, which puts my 210 "oh God" print on the table, no?

Let's be clear here: There is no way out of this box, and the corruption and fraud have permeated every corner of our financial, media and governmental systems.

We give "free" education and health care to illegal aliens, paid for out of citizen tax dollars. Our government supports this.

We propose to give "foreclosure relief" to people who lied on their mortgage applications; how many of the so-called "rescue" programs would have ANY uptake among the public if as part of the refinance or assistance process the original paperwork was re-underwritten to discover if you lied, and if you did, you were prosecuted instead of being helped?

We have done exactly nothing to indict and prosecute the banking executives, the housing industry executives and others in the business world who contributed to these lies and frauds, in some cases explicitly.

The Congresspeople who got "special deals" from Countrywide Financial (and others) on their mortgages remain in office and are not being charged and tried for what, in my opinion, amounts to public corruption. The amounts involved here are not small - the "savings" in many cases ran into the tens of thousands of dollars.

It has been disclosed that several sitting Congressmen received tens of thousands of dollars in campaign contributions from Stanford Financial (now under investigation on suspicion of not only bilking investors but also money laundering!); the firm also allegedly gave eight hundred thousand dollars to the Democratic Senatorial Campaign Committee during a year that Congress was debating a bill that would have tightened anti-fraud provisions against the securities industry. The bill was killed in a Senate committee.

We learned that government employees are also profligate tax cheats! Not only the high-profile ones like Geithner and Daschle either - this is an across-the-board problem:

The Internal Revenue Service is trying to collect billions of dollars in unpaid taxes from nearly half a million federal employees. According to IRS records, 171,549 current federal workers did not voluntarily pay their federal income taxes in 2007. The same is true for 37,752 active duty military and nearly 200,000 retired civilian and military personnel.

Documents obtained by WTOP through the Freedom of Information Act show 449,531 federal employees and retirees did not pay their taxes for a total of $3,586,784,725 in taxes owed last year.

What?! Oh, and with the exception of the IRS, you can't be fired as a government employee for not paying your taxes either. You can't make stuff like this up folks - nobody would believe you.

I'm tired of people demanding that I cover the bad bets they made as a consequence of fraud throughout the system, while the people responsible, including those in industry and Washington DC go unpunished.

The fruit of a poison tree is also poisonous and if you were a victim of that fraud (that is, you didn't knowingly buy a house you can't afford, you didn't overstate your income and you didn't intentionally speculate on home price appreciation - you instead bought responsibly, you didn't exceed 36% DTI on the back end, you put significant money down and you took a conventional mortgage - not one of those fancy "Option ARM" rent-a-house products that you'd NEVER be able to pay off on the original terms) then you should be looking to those who DID commit fraud for recourse, not the government and everyone else's tax dollars.

If on the other hand you did overstate your income, you did take out an OptionARM, you did lever yourself up to your neck, you did play the "House is an ATM" game or you did speculate with your house then you deserve exactly nothing for help because you participated in an intentional attempt to game economic and financial reality and lost.

Now for those who merely speculated and lost (and there are a lot of them) I believe we should reverse the Bankruptcy "reform" act so you can access the courts and find relief, both spreading the pain to the lender who imprudently granted you credit and accepting a lot of that pain yourself in the form of a destroyed credit rating for the next seven years.

But for those who overstated their income or otherwise committed some form of fraud - and let's be clear here folks, mortgage fraud is a federal offense - what those people deserve is a long stay in prison.

Since we seem to have a shortage of prison space I recommend that we immediately decriminalize all non-violent drug possession and consensual sales between adults, expunging their sentences and releasing those prisoners. We can then tax drug sales (and sell them in DRUG STORES, which are conveniently named), use the money to pay for treatment programs, but more importantly we will have plenty of room to jail all the fraudsters, including the banking executives and Congresspeople that got us into this mess.

Our economy must contract to a sustainable level - period. This is not a matter of what we want, it is a matter of what is possible.

A bubble economy built on fraud cannot be reflated once it pops and the fraud is exposed at the level to which it occurred in this case. It is simply not possible.

We must deal with the underlying rot in our financial and political systems, and until we do in a forceful and forthright fashion we will continue to see economic malaise and destruction.

Wake up America.

To The Republicans

nospam@example.com (Karl Denninger) — Thu, 12 Feb 2009 12:41:15 -0500

Ok, you lost the election.

But your response to what has happened thus far with the Obama Administration ranks somewhere below "pathetic" and is dangerously close to "puerile."

You are still soliciting people to donate to the RNC under the rubric that you were and are a better choice. Your standard-bearer, McCain, made a fool of himself in the Senate the other day. And you still maintain that "tax cuts" are the fix for all that ails us.

If you want any chance of ever having a majority in Congress again, say much less The White House, you need to cut the crap and examine why you lost - then change it.

Here's the facts folks:

The Republican Party not only sat idly by while various banksters and their pals looted the public and the Treasury, they were actively complicit in allowing it. Paulson came to a republican Congress and SEC to ask for leverage limit removal in 2004, remember?
These frauds and scams, the root of the problems in our economy, were not born overnight. The CRA was not a major part of this. Not by any stretch of the imagination. The root of this credit bubble was the willful and deliberate destruction of oversight and regulation that would have prevented it from happening. Specifically, the evisceration of reserve requirements via sweeps and other games and the evisceration of leverage limits via off-balance-sheet nonsense, "deregulation" of the banking and Wall Street investment houses and willful blindness to blatant corrupt and fraudulent practices. Both political parties were evenly involved in the creation of this mess.
The reason this mess got out of hand was excessive leverage. For the last 20 years the banksters and their cronies (including a whole bunch of Republicans) have dismantled regulations capping leverage at sane ratios. The only way to prevent this from happening again is to reinstate those limits.

If you want to regain power in Washington DC and once again become a party of the people, you can - since it appears The Democrats are refusing to step to the forefront and seize the opportunity (damn foolish of them too, as they have power now and were they to take this advice they would literally feed The Republican party into a wood chipper feet-first) then you must become the "first mover" and shift the debate.

Americans are angry, and with just cause. The 535 Moes, Larrys and Curlys on Capitol Hill have taken hundreds of millions of dollars in campaign contributions which have purchased the right to blow serial bubbles and skim off fraudulent profits - their scheme of serial fraud has collapsed, destroying the average American's retirement, job security and economic prospects.

Here's the prescription to fix it now and forward - your platform on economics:

Reinstate Glass-Steagall. No more "Chinese Wall" nonsense. If you're a commercial, government-backed bank that accepts customer funds (e.g. anything with an FDIC guarantee) you may not offer investment products of any sort (including insurance-style products such as annuities) nor may you have cross-ownership or control with a firm that does. Period. Banking - the fractional reserving of depositor funds and issued debt for the purpose of issuing loans - is a utility function and its plenty profitable (if a bit stodgy) when operated as one.
Drop the 10% deposit concentration cap to 5%, and give existing banks that are over the 5% limit three years to get under it by splitting off or selling off assets. This applies to fewer than 25 institutions, and it needs to happen right now to control systemic risk. Bluntly, if you're too big to fail you're too dangerous to the banking system as a whole. See #1 above - commercial/retail banking is a utility function and should be regulated as same.
Repeal the "Bankruptcy Reform" law. Consumers must have the same right to go bankrupt and discharge debts that corporations have. Banks and others who grant loans must have this Sword of Damocles over their head - you make a bad loan and the borrower can file Chapter 7 and stick you with it, without exception. This will immediately collapse the outrageously overpriced bubbles that remain and are credit-driven, including post-secondary education.
Remove the obscure little change made in the EESA/TARP legislation that allows Bernanke to set the reserve ratio to ZERO for banks, and set it statutorily to 8%. Enhance the law by declaring that ALL funds taken in by a bank irrespective of their source are subject to the 8% reserve requirement (thereby removing the "sweeps" exemption that started this mess.) This will force leverage in the regulated banking system to no more than approximately 12:1.
Set the lawful leverage limit to 12:1 for all investment banks and other entities including hedge funds. Any firm that wishes to be domiciled or operate in the United States must comply. Period. I know what the counter-argument is - "they'll go somewhere else." Fine! Go blow up some other nation's economy. We've had enough of it.
Said 12:1 leverage limits must apply to all assets. Yes, even US Treasuries. If you hold it at most (for the safest assets) you can gear it at 12:1. Period.
Ban all off-balance-sheet vehicles; no exceptions of any sort. If you have control of it or are responsible for it in any form or fashion you must consolidate it on your balance sheet. "Shell corporations" set up to evade this requirement that have no capital or assets of their own are deemed a fraudulent shell company. Close the SIV loopholes.
No more Level 3 anything may count as "assets" and all model-marked assets in Level 2 must be disclosed specifically along with their pricing models and the inputs for same in quarterly and annual reports. The proper disinfectant for chicanery and fraud is sunlight. If a regulated or public company wishes to hold an "asset" without marking it to a market price they're free to do so - what they're not free to do is claim a value on it. This forces the recognition of the "worst case" value of all such "assets" at inception; there can thus only be upside surprises when they are eventually disposed of. Bingo - no more incentives to claim "value" that doesn't exist.
Bar the trading of derivatives contracts by commercial banks except where those contracts are backed by or insure a hard asset (e.g. a CDS on an actual bond or mortgage) and they are exchange-traded with a central clearing counterparty and thus guaranteed "good". If some Hedge Fund wishes to write or hold naked CDS and immolate themselves that's fine, but they cannot blow regulated financial firms (including insurance companies) to pieces nor can they distort share and debt-pricing mechanisms in the public, regulated markets.
Bar The Federal Reserve from any action that results in other than fully-collateralized lending. Further, force The Federal Reserve to publicly post in real time all transactions they undertake identifying the counterparty, the asset(s) taken in as collateral and the terms thereupon so that the public can verify that violations are not taking place and favoritism is not being employed.
All derivatives traded by regulated financial entities must be cleared and traded through a public exchange with a central counterparty, nightly margin supervision and published bid/ask/open interest.
Extend bank fraud statutes to explicitly cover actions taken by The Fed or any banking or financial institution in violation of statutory limits and name the members of the board of any such institution as personally responsible for violations. This stops the game-playing where institutions feel free to be "fast and loose" because all they will get is a slap on the wrist by FINRA or the SEC. With these offenses being federal criminal offenses the calculus changes immediately on what someone will and will not attempt.
The Republicans are the party of "law and order." Calculate the economic impact of violent crimes and set penalties for financial and other "white collar" criminal offense commensurately. For "white collar" criminal offenses that have more financial impact than an actuarial analysis shows would be the case for a murder, the appropriate penalty is life imprisonment without the possibility of parole. Change the law to make it uneconomic to pull scams and many of the scammers will stop. Those who don't we lock up and the good news is that unlike most violent offenders the scammers have enough money to pay for their own incarceration via disgorgement proceedings.
Stop trying to prop up asset (especially house!) prices. Instead, preach the truth - affordable housing means no more than 28% of your income goes toward all housing expenses, you should put 20% down, and you should not take anything more aggressive than a 30 year fixed-rate loan. For many areas this means median home prices must still contract. A house is shelter, not a speculative vehicle.
Make the following changes to the ratings paradigm:
1. Ratings agencies have no "speech" protection for opinions that prove flawed due to errors, omissions or acts of commission.
2. All data used by said agencies must be made available for verification by individual or firm that wishes to verify a claimed rating (e.g. no "proprietary" lockdown on data which is inhibiting firms like Egan-Jones from being able to fully analyze deals)
3. Purchasers of instruments may not rely on ratings soundness for "haircut" or "reserve" provisions under BASEL or similar regulations unless they paid for the opinion (that is, it was a "buyer's opinion", not a "sellers opinion".) Absent same the instrument is considered "unrated" for reserve purposes.
4. NRSRO certification is removed; any firm that wishes to offer opinions on debt instruments is free to enter the business.
Pledge to lock up all of the parties who engaged in fraud during the bubble years and to seek and obtain disgorgement of all of their profits, stock (restricted or not), salaries and bonuses during the time the fraud was going on.
Ban all "dark pool" trading. You want to trade it, the market has a right to know about it. Transparency and honest markets require public disclosure of bid, offer and size. Period.
The Fair Tax. Period. No more IRS. No more BS. No more lobbyists gaming the system. Nobody has to file a tax return ever again, save businesses who already do monthly for their sales tax returns. Taxation becomes completely transparent and voluntary based on your desired level of consumption. It is a radical step, it will create a huge boost to GDP as every firm that has fled the US for Bermuda and similar will repatriate and in addition it will cut the compliance costs out of every American's budget. Finally, it will tie government income inexorably to GDP, prohibit raising taxes without it being instantly visible to the public and provide incentives for capital formation - exactly what we need to create millions of new jobs.

The bank "stress test" that President Obama has proposed is a good start - provided that it is "clean". I have my doubts. I was planning on penning a Ticker on the "stress test" this morning but frankly one of the forum's brighter lights, Mtgspy, penned a blog entry that says it at least as well as I could have - go take a read.

The essence of why we continue to have these zombies walking around and the shorts are pressing their bets in all markets they can access is simple - the banks continue to run their scam by keeping all their worthless toilet paper in "Level 3" at or near par. So long as this charade continues - and it will until the cashflow shortfall from these "assets" forces their free cash flow below zero or the cops put a stop to it - the market cannot and will not clear. This has resulted in a loss of fifty percent in the equity markets, and we both can and will lose another fifty percent in short order (and perhaps another one after that!) until and unless this game is stopped.

Private investment money will not return until the fraud is flushed out. The people with private capital have been screwed blind by the charade of "Level 3" toilet paper sold off as "Grade AAA" securities, suffering hundreds of billions of dollars in losses, along with more than $10 trillion in public equity market losses. The banks have literally trillions of dollars of so-called "assets" marked at or near par because they don't like the market price, with even more held off-balance sheet in ENRON-esque structures that must be collapsed. Many of these "assets" are fully-synthetic monstrosities or second lines that have no actual physical asset behind them - they're literally unsecured credit with no real hope of principal repayment despite claims to the contrary. They are worthless or nearly so, despite the protests of those with "computer models" and as the market has seen through these fictions money has fled the markets.

There is only one way to get that capital back into the market and working - the frauds must cease, the malefactors must go to jail, and the bright sunlight of truth must shine upon the firms and individuals involved in this charade from the top down.

The political party that does this owns Washington DC and The White House for the next 20 years.

While lobbyists make lots of campaign contributions they cannot vote. The body politic, on the other hand, can and does, and it is looking for real change, not faux promises wrapped in a fancy suit that hides yet more used toilet paper - all marked "AAA", of course.

"Here It Comes"

nospam@example.com (Karl Denninger) — Sat, 31 Jan 2009 01:00:00 -0500

I've noted that a few people have cast questioning eyes at my triangle, and the 210 target off it.

Some have claimed that I should be using a log scale on that chart.

Yeah, yeah. I've heard that.

Now let's look at what we've learned the last few days, weeks and months:

California appears to be functionally insolvent. As in now. How far is the state from widespread inability to pay police officers and firemen, and how long does it take before widescale riots break out when those who leach off the government teat for a living have their checks interrupted?
It is increasingly clear that there is absolutely no way that the "big banking system" comprised of firms like Citi, Bank America, JP Morgan and Wells Fargo, along with a handful of others, can make it through this without one trillion or more in additional funds. Yes, it really is that bad.
It is also increasingly clear that there are literally hundreds of midsize and smaller banks that are perfectly fine. They did not lever up, they did not write a bunch of crap commercial or residential construction paper that cannot be serviced and they most certainly did not drink the KoolAid of securitized synthetic garbage debt. Even in bad economic times traditional banking is a very profitable business - so long as you lend money to people who can pay you back or you have sufficient collateral so that if they default you don't lose your shirt. These sound banks have been frozen out of the "money fountain" and also out of the opportunity to be rewarded for their prudence. The Fed's policies have made it impossible for them to attract capital at any reasonable deposit or CD interest rate and yet their capital ratios are very healthy. These firms should and must stand and yell NOW. There is nothing wrong with the banking system. There is plenty wrong with a handful of big banks who engaged in outrageous and possibly even criminal conduct.
Speaking of possible criminal conduct, it has now been revealed that Indymac was not the only bank that improperly booked funds and violated reporting standards - there were four more. The government has refused to identify them. Gee, can you think of four Thrifts that got in trouble in the last year and disappeared? It's not difficult is it? FOIA's anyone? Speaking of which, where's that new President Obama "transparency" in government?
Ben Bernanke's neoclassical monetary theories have been proved incorrect. He has doubled base money in the last few months. Under neoclassical monetary theory this should have immediately produced inflation as the increase in base money would have spurred an increase in credit money (cash and credit are not the same thing, although they spend the same.) However, neoclassical monetary theory relies on a false premise - that the existence of additional base money causes the creation of credit - that is, the monetary tail wags the credit dog. In fact it is the other way around - credit is the dog and the tail cannot wag the dog. When worthy borrowers refuse to take out additional loans and unworthy borrowers cannot borrow additional base money has no effect, because each dollar of credit money must be matched by a dollar of debt. No new debt issue, no credit money expansion. Debt cannot expand because the carrying capacity for it in the economy has been reached, ergo absent Weimar-quantity printing of raw cash (on the order of $20 trillion dollars!) deflation cannot be halted until the bad debt is forced from the system. This excess came about because of knowingly unsustainable leverage - that is, credit-to-money ratios. Unfortunately until the total leverage in the system is reduced to sustainable levels there is nothing that can be done to halt demand destruction and economic contraction. Transferring leverage from the private sector to the government cannot change this outcome. In an economic system where most monetary exchange is in fact credit deleveraging always produces deflation which cannot be halted until leverage ratios return to sane and sustainable levels economy-wide.
A nation's standard of living is not based on its ability to borrow in aggregate, but by its ability to produce. Therefore, we cannot borrow our way to prosperity nor can attempts to "spur lending" lead us out of recession. Rather we must produce actual goods and services - not push paper - to grow our way out. Over the last 20 years we have replaced production with false claims of "wealth creation" that are nothing more than the creation of additional credit through intentional mispricing of risk. That scam has now come to an end as the true lack of value has been exposed. All major busts in reasonably-modern time (e.g. back to TulipMania) have come from credit excess.
Ben Bernanke and Alan Greenspan before him had the responsibility and authority to regulate the credit system, as did the OTS, OCC, SEC and Congress. ALL abdicated that responsibility; Congress in particular appears not to understand how these functions work, but the other institutions do and their abdication was willful.
There are all sorts of theories about why prices of both stocks and bonds fell this last couple of weeks. They are all wrong. There is only one reason - supply and demand. Treasuries are being rained into the market like a monsoon and this is depressing price; what's worse is that it is sucking up money from the system which then causes a supply:demand imbalance in stocks. In order to issue the sort of supply necessary to fund the grand schemes of former Treasury Secretary Paulson, the last and present Congress and President Obama, as well as "keeping the promises made" by the previous administration (some $7 trillion worth!) the amount of supply that must be issued will literally destroy both stock and bond prices.
We now know that not only Tim Geithner evaded taxes but in addition Tom Daschle, Obama's Health and Human Services nominee, failed to pay $100,000 in back taxes and interest. What's worse is that those taxes were incurred due to a car and driver provided Mr. Daschle by a private equity firm raising very serious conflict of interest issues. Where is my "change that we can believe in" Mr. President? I see only the very same corruption and influence peddling that Washington DC has been known for.
There is a tremendous amount of anger rising in America. You don't see it - yet - in public, but it is there, simmering just under the surface. President Obama made note of it when it was revealed that nearly $20 billion was paid out in bonuses to Wall Street firms this year - after they took $70 billion of taxpayer money in direct assistance. That's about 30% of the total that went right out the door as bonuses. In effect, we are now paying taxes so that Wall Street can hand it out to the very people who got us into this mess!
Government tax receipts on all levels are cratering. Income tax and sales tax numbers are frightening with many state governments reporting double-digit drops in the last month. All these handouts and bailouts sound good but where is the money going to come from? When the money runs out the game is over in truly-spectacular fashion.
Speaking of which The Bond Market issued its statement of displeasure over the last two weeks on the idea that we'll just blow money left and right.
Finally, that taxpayer anger and falling tax receipts, plus the government continuing to hand money to people who demonstrably not only made bad bets but engaged in outrageous and perhaps even illegal and fraudulent conduct, yet have returned nothing of what they stole sets up a very real risk of a tax revolt by Americans. It would be ruinous and nearly impossible to control if Americans decided en-masse to simply refuse to pay and to the extent possible went "off grid" through barter and underground transactions, or started modifying W4s to greatly limit withholding and then simply didn't file. Anecdotes related to this occurring are already popping up. I realize this is extremely illegal but at some point the American public is going to reach it's breaking point with the government literally stealing their money to bail out those who robbed them in the first place!

There are rumors of a "big bang" financial cleanup coming next week from the Administration:

The “big bang” approach reflects the belief of Tim Geithner, Treasury secretary, and Lawrence Summers, National Economic Council director, that the Bush administration was wrong to dribble out policy initiatives. Mr Geithner intends to present a “comprehensive” plan that policymakers hope will command market confidence.

Details of the financial overhaul are being finalized and have yet to be approved by President Barack Obama, but it may include both the purchase of toxic assets by a “bad bank” and insurance-style guarantees for problem assets remaining on bank balance sheets.

Anti-foreclosure efforts are likely to focus on subsidizing programmes that reduce unsustainable monthly mortgage payments, though there may also be support for schemes that subsidise the partial writedown of loans that exceed the value of the home. Treasury may also unveil new efforts to revitalise dysfunctional securitisation markets.

If this is all they intend to do it will fail spectacularly and the odds of a full-on market meltdown become very high because in fact this is nothing different, in reality, than what has been done thus far - and has failed.

I want to expand on the bond market problem because it is absolutely critical to understand this, and for the Obama administration to put an immediate halt to it.

Prices respond to only one thing in "reality" - supply and demand. Both can be illusory which produces short-term distortions but the truth always pokes its head through and when it does, the direction becomes clear.

Treasury, The Fed and Congress (the previous one) have in aggregate promised some seven trillion dollars in spending they do not have. This of course will eventually require issue of debt to find it in one place or another. The current spending plans of both Treasury and Congress are guaranteed to require upwards of $2 trillion of issue this fiscal year (running through September 30th.)

This last couple of weeks Treasury has been issuing bonds like crazy and as they have bond prices have taken a dive into the mud. Why? Because the supply has to be taken up by someone so that Treasury can fund the nation's promises, and as that supply is taken up money is sucked out of the system to buy those bonds. This then upsets the supply and demand picture in equities.

Reality has started to intrude into the market and it's not a pretty picture. FCBs sold Treasury and so did Primary Dealers in the most recent week. This is new, it is ominous, and it signals that market participants in the bond market have detected smoke in the room. Should they all rush the door at once the bond market dislocation that I have been warning of for months will gather steam and cut off federal funding, along with kneecapping the stock market. The Fed cannot possibly absorb this supply as it will not be limited to Treasuries; they would have to print up literally $20 trillion dollars to halt the collapse and should they attempt it the dollar would collapse instead as that would be a literal ten times over expansion of the monetary base. This would produce a monetary and market implosion twice as bad as what occurred in Iceland overnight.

This is where neoclassical monetary theory meets reality. In the real world credit leads, it is the dog and money supply is in fact the tail. When regulation of credit is abdicated to the degree we have seen in the last five years the resulting credit collapse cannot be avoided through diddling monetary and fiscal policy as the tail cannot wag the dog.

We stand on the edge of the failure of all of American's retirement assets. Literally all of them. Buried in some of the earnings reports of the last quarter are the fact that half of the market capitalization of some firms was wiped out in the last year due to pension fund shortfalls as a consequence of the stock and credit market swoon. CALPERS and other funds are rapidly going from being adequately capitalized to critically undercapitalized. If the Treasury and Stock market both sell off as I believe both can and is likely to happen if the current policies are continued essentially ALL American Retirement Assets will be destroyed - 401ks, IRAs and both private and public Pension systems. Total losses through these systems is likely to reach 80-90%, and the Boomers start retiring "en-masse" just a few years from now.

In short, if policies are not changed now there will be no retirement for Americans and the currently-retired who rely on these funds will find them gone and be forced back into the workplace. Unemployment in that scenario is likely to reach and may exceed 20%, and what's worse, Medicare funding will be severely curtailed at the same time due to the inability of the government to fund it.

It is absolutely critical that Obama and Congress understand these facts (and they really are simple; we have $53 trillion in public and private debt - that is, credit - and yet the monetary base is just shy of $2 trillion up from the "normal" $800 billion or so) - it is not mathematically possible for a $2 trillion dollar thing to control the outcome of a $53 trillion thing, especially when you are threatening to add $7 trillion to it.

Let me put forward a different view of what should be done, and hope that President Obama and his cabinet direct Geithner and company to take these actions. I fully realize that parts of this call for Geither to "turn on" some of his banking buddies, but irrespective of his desire not to, if he does not then the plan will fail.

Specifically, we need to, here and now today:

Make at least $100 billion dollars available to existing good banks in additional capital so they can take on the good assets of banks that cannot survive in their current form with their current losses and balance-sheet garbage. (This, by the way, includes the off-balance-sheet junk that has magically "disappeared" from the public's radar, but you can be certain it IS still there.) This is essential so that the banking system, as opposed to individual banks, remains operational now and into the future. The "your ATM card doesn't work" scenario must not be allowed to occur.
The "bad banks" that created this mess must not be further rewarded. The public simply won't stand for it. This is no longer an option and if President Obama and the rest of the government is too tone-deaf to understand this they will make a monumental mistake. Americans tolerated the first $350 billion going to these clowns because we were told that they would use it to restart lending and that it was necessary to prevent an all-on economic collapse. The money was spent on bonuses, acquisitions, and stuffed in The Fed's vault where it now earns interest, proving beyond a doubt that the original claim was a lie. If Washington thinks they'll get away with this a second time they are sadly mistaken.
The "promises" made to backstop the failed credits represented in Freddie, Fannie, AIG and elsewhere cannot be kept. Read back through the above - if Government continues to attempt to issue Treasuries into the market they will precipitate both a bond and stock market collapse. This is a mathematical reality and the market has been issuing warnings now since the beginning of the month. January was the worst "first" month of a year for the market ever and yet the new issue from Treasury was a tiny fraction of the refunding and new issue that is currently scheduled for the next few months.
To deal with the "bad banks" we have only two choices - we can either:
- Strip them of their good assets and sell those off to the good banks, then cut them off from all public assistance and let them fend for themselves, having protected the good assets (and deposits) by placing those with sound institutions OR
- "Cram down" their equity and debt structures and resolve their balance sheet issues in this fashion.
ALL debts must be settled - either reaffirmed with capital adequacy and ability to pay proved up or those debts must be forced into the open and restructured or defaulted. The game of "hide the sausage" among financial institutions cannot be allowed to continue; confidence must be restored and it cannot happen until and unless everyone knows that all balance sheets fairly represent a firm's assets and liabilities. The lying has gone on for long enough that nobody trusts anyone; only FULL TRANSPARENCY resolves this problem. This includes, by the way, the garbage held by The Federal Reserve - it must be forced into the open and valued with 100% transparency today, tomorrow and every day thereafter.
President Obama has said that he intends to try to create "4% Mortgages" to "help the housing industry." Such a move will do no such thing; the market will not permit 4% mortgage rates when the cost of long money is higher than that by any mechanism other than direct subsidy. Since housing is a $30 trillion (roughly) value proposition and roughly 40% of all homes are mortgage-free even providing one percent in subsidy would cost about $150 billion a year and the worse news is that adding this to the debt load of the government would likely drive the differential much higher. At 3% such a move would run $450 billion, or more than the entire first half of the TARP - annually! This is clearly unsustainable and President Obama must stop drinking this KoolAid. The solution to housing affordability is lower home prices, not higher ones.
There must be a public statement and immediate follow-up action from the Obama Administration on the massive fraud and abuse of the public that has occurred over the last ten years with regards to securitization, mortgage fraud, appraisal fraud and other various ENRONesque acts by the giants of Wall Street. The public wants blood and Washington had better pay attention on this point; you have hundreds of thousands of Americans who have lost their homes and close to five million who are on the continuing unemployment rolls as a direct and proximate result of this nonsense. The government cannot contain five million angry Americans with platitudes or, for that matter, anything else. There are in fact lots of "bad actors" in this mess who at minimum profited from intentional deceit in the pricing, securitization and intentional blowing of this credit bubble, and it is unjust that they are allowed to get away with it. Everyone is entitled to a fair trial but the public must know that the investigations are in process and prosecutions will be forthcoming as is appropriate. Government must not be seen as the felon in the eyes of the people or it's authority, both moral and legal, will be lost.
Government must not act in any fashion that may cause confidence in Treasuries to be lost. This means that the trash-taking games of Treasury and The Fed must be halted now. We may be too late to prevent this and the market has issued a clear and loud warning of the potential consequences over the last month. Should the dislocation that I have warned about over the previous year occur government's funding model would be effectively cut off, forcing an immediate termination of Social Security, Medicare, and half or more of all military spending. This in turn would cause a spiraling collapse of tax receipts which in turn would squeeze government finances even further. Government must have contingency plans in place for what it will do if 75% of its financing capability simply disappears. It both can and may happen.
Government must be prepared to provide the basic necessities of life for at least five to ten million Americans and possibly as many as fifty million - one in six. As I have noted before this means barracks-style places to sleep, food, clothing and basic medical care. Hungry, homeless and unemployed people are dangerous.
Government must deal with the illegal alien issue. We simply cannot have tens of millions of illegal aliens consuming public resources at a time like this in our nation - period. Americans will pick strawberries if they're unemployed; that we have illegal immigrants doing this sort of work with 5 million Americans out of work is an outrage. Again, if government does not act there is a high probability that the American people will, with disastrous consequences.

Finally, for those who think that SPX 200 and DOW 2,000 is a "pipe dream" let me point out that the DOW was at 2000 in as we turned into 1988 and the SPX was at 250. Pipe dream? Not at all. When did the insane credit creation antics begin? Shortly after the 1987 crash, that's when. Here's a long-term chart - you tell me what "mean reversion" takes us back to.

Oh, and yet another basic technical analysis principle is that an "M" formation (otherwise known as a "double top") usually retraces the at least the entire run that produced the left-side of the "M". We can argue over whether that's 200 or 450 - either is really, really bad.

President Obama must decide - he either stands for this nation, the Constitution (as he pledged when he took the oath of office) and its citizens or he stands for the fraud, abuse, and raw theft that has been perpetrated against us all.

The markets have sent a clear signal over the last month - attempting to "borrow and spend" to prop up failed institutions and shield them from the consequences of their bad decisions, when those bad decisions exceed in aggregate the federal budget, cannot be done. If Treasury attempts to issue the amount of supply necessary to fund this it is virtually certain to cause a major meltdown in both the stock and bond markets, and this may be right around the corner as the quarterly refunding is upon us.

There is no middle ground and President Obama must choose.

Our new President was elected to office by the people who were tired of Washington DC influence peddling, pervasive fraud and theft and the economic damage it has wrought on this land. President Obama now has two high-level appointees he has continued to support after they were revealed to have "ethics issues" (at best.) If President Obama does not choose here and now to stand with American citizens and against the fraud and corruption of the previous twenty years he will at best be a one-term President and at worst there won't be an economy or nation worth being President of within the next year or two. The situation really is this grim and neither the markets or the people are going to sit still for any more of "business as usual." Words will not cut it - it is only deeds that count now.

This is not the time for "bipartisanship" or any such thing. It is time for President Obama to demonstrate that he is the leader the people elected and to stand up for the common man - not through "paying back" organized labor with things like "card check" and ordering the removal of disclosure statements of union worker rights related to the ability to "opt out" of political activity, but rather by standing with the common man against the pervasive fraud, abuse, theft and lies that have been perpetrated by Wall Street, K Street and Washington DC in general over the previous twenty years.

The road ahead is a rough one. Our nation faces an unprecedented economic mess of which we have only seen the beginning, but that mess is of our own making. We have "enjoyed" false prosperity for more than a decade fueled by intentionally-overinflated asset prices that represented not real wealth but rather a chimera grown from ridiculous and outrageously fraudulent actions by many throughout our credit, banking and regulatory systems.

The blame for this cannot be laid at the feet of either political party to the exclusion of the other. Both sides of the aisle are to blame, as both have held the reins of power during this period of time. There are dozens of Senators and Representatives who have dirty hands, including many who personally profited from "special deals" doled out by some of these firms, in many cases to the tune of tens of thousands of dollars. Reported frauds have been intentionally ignored and both lawmakers and regulators have not only looked the other way but in many cases have been actively complicit.

Our nation truly stands on the precipice of history. We cannot borrow and spend our way out of this mess, we cannot pass $800 billion dollar "stimulus bills" that do not actually stimulate the economy and we cannot rob Peter to pay Paul. Asset prices must contract to reasonable, supportable values, and they will - whether we like it or not. Those who are overlevered and in debt up to their eyeballs will and must default, and have that debt cleared. Transparency must not be a word, it must be a deed throughout our financial system and markets.

Where We Are, Where We're Heading (2009)

nospam@example.com (Karl Denninger) — Wed, 31 Dec 2008 11:33:20 -0500

Let's score the 2008 edition predictions first:

US will enter a recession: Confirmed by NBER. Check.
Unemployment will rise north of 5%. Check (bigtime)
Housing will not turn in 2008. Major check.
The story in 2008 will be defaults on prime mortgages. Check.
Consumer lending practice stupidity exposed. Check.
Recreational sector (boats, etc) smashed. Check.
Government will meddle. Biggest check of all!
Buffett will win on munis. Miss - a clean miss.
Equity prices will at least touch 1220, target of 1070, no surprise on a three-digit handle for the SPX. Major check.
Return of capital is the dominant theme. Check; 0% IRX anyone?
No "hyperinflation". Check.
Debt to be paid down and/or defaulted. Half a check. The hiding continues, and so far, there's no indication that the end of that rope has been reached.
CRE will collapse. GGP anyone? Check.
Business CapEx will go to hell. Check.
Dollar will strengthen. Check.
Market callers coming to the public "hat in hand". Nope; clean miss. Where's Cramer committing Seppuka on national TV? Oh well; hubris knows no boundaries.

16 predictions, two clean misses and one half-miss, the rest either panned out or were proved tremendously conservative.

That's not bad. Anyone else got a public scorecard? Cramer? Kudlow? How about Dickey Bove? "Generational buy eh? Hmmm....

Let's recap where we are today:

Debt has risen at a faster rate than GDP for the last seven years. This has led to a falsely-stated increase in GDP, in that when debt rises faster than GDP (on a percentage of GDP basis) what you're doing is financing expansion through debt that is not being paid down through production. Due to the nature of interest, that being the compound nature of it, this constitutes a pseudo-Ponzi Scheme that must fail. It now is failing, yet The Media continues to report falsehoods on exactly what is going on with households (and for that matter, businesses as well.)
The Federal Reserve has continued to pump "liquidity" into the economy, which is their job, but they have also continued to cover up fraud and blatant thievery, which is antithetical to their role as the primary regulator of the banking system. This is what Japan did, but they had savings to cushion the blow of their idiocy. We do not - we only have debt. Note that it did not work in Japan in that they have had below-trend growth for more than 10 years and now are facing a second, disastrous leg downward. Why anyone thinks it will work here with a higher debt-to-GDP ratio defies logic - but this is the altar being prayed at.
As The Federal Reserve and Treasury actions have proved inadequate they have continued to do the same thing but with ever-larger amounts of money that doesn't exist, committing to borrow ever-larger sums. This simply accelerates the first problem.
Neither Treasury or The Fed has a damn clue as to what they're doing. The SEC's Chris Cox and various members of Congress have confirmed this repeatedly, stating clearly that both Bernanke and Paulson have come to them with demands for immediate action backed by outrageous claims of immediate collapse of the entire financial system, martial law or both if they do not acquiesce to their demands, even though less than a month prior (and for the previous year!) these same people were claiming that our economic issues were contained. The only possible explanation for this behavior is that these two men were and are incompetent, insane, panicked and unable to think clearly, concerned that their complicity in this mess is about to be exposed (and it will end very badly for them) or all of the above.
Many of the actions of both Treasury and The Fed are of questionable legality - at best. The worst abuses include claims of "transparency" on the TARP that have simply not been met and The Fed creating over one trillion in new debt against the taxpayer without an authorizing bill in The House - a flatly unconstitutional act that in a true Constitutional Republic would have led to the immediate de-authorization of The Federal Reserve as the nation's monetary authority. More recently Treasury has actually been kiting checks on the TARP (they have committed $10 billion more than authorized thus far); that's a criminal offense if you do it with your checking account.
All of the above have taken what was a 10% correction in GDP that was necessary in 2000 (and which was primarily centered in businesses) and moved it to a nearly-30% correction in GDP that is now necessary. If we continue down this path and actually spend all the so-called "committed" funds in 2009 as would be expected, the net contraction in GDP necessary to bring the system back into balance could reach 50%. This level of contraction would be catastrophic and could easily threaten the political viability of our government, not to mention 30% of American jobs and incomes.
President Obama has "threatened" to spend north of $1 trillion in "stimulus", but in fact the nation doesn't have that $1 trillion. You cannot go further into debt to avoid the consequence that arises from excessive debt in the first place! If President Obama does not realize this fact and change course before he (and Congress) spend this money the odds of that 50% contraction go up precipitously; the $1 trillion expenditure alone will "back load" yet another 5% onto the GDP contraction that must come. This is an act of pure lunacy and yet it appears to be precisely what our government intends to do.
The cockroaches have scurried as their cover is withdrawn (Buffett's "swimming naked" analogy) and this has continued apace all year, with the latest being Madoff. We've developed a quite-impressive list of ignored warnings going back 20 years; subprime, banking "regulation", securities dealers running ponzi schemes and Treasury Secretaries lobbying hard (before becoming Treasury Secretary) for leverage limit removals that prove to be the trigger for the crisis.
Madoff is not what it appears to be. At best Madoff is a 20+ year scam that occurred with not only the intentional blindness of our government but its explicit assistance and cooperation. It is simply not possible for one man to run a Ponzi Scheme of this size, sending out statements every month to hundreds if not thousands of clients and employing a group of people, moving this amount of money around, and have the entire thing be a scam without the cooperation of literally hundreds of accomplices including accomplices inside regulatory agencies and the government itself, along with regulated entities including the banks that lost money. You cannot place that sort of capital as a bank or other regulated entity on nothing more than "trust" - no matter who its being placed with. There is much, much more to this scandal and you can bet the people involved will do their level-best damndest to keep the truth from coming out. Never mind the fact that explicit warnings were transmitted to the SEC.
Job loss has risen and shows no sign of topping. Don't expect it to any time soon. Be aware that unemployment peaks after recovery is already well underway. This makes unemployment a good indicator of misery but a horrible one for where we are in the economic cycle; as such looking for this to "bottom" is a terrible idea if you're an investor.
The number of "bottom callers" have increased dramatically. Don't believe it. The S&P 500's forward earnings for next year is still estimated around $70 (!); that's lunacy. The banking model for earnings is permanently broken and they will return (after washing out) to the "Grandfather's banking" sort of earnings - slow and steady with growth limited to that of GDP. IMHO the S&P 500 will be lucky to post $50 in earnings for 2009. Bear markets frequently bottom with a single digit P/E multiple, which puts the SPX at or under 500 before this is over. We are still 40% overvalued by this metric!
The 20/50W (and 13/34 EMA) timing signals are not only on a SELL from early 2008, they are still getting more divergent toward the sell side. I will simply observe that those who try to be heros in the market often wind up with zeros in their account. Until these timing signals flip the primary trend in the market is down. This doesn't mean you can't make plenty of money trading bear-market rallies, but it does mean that if you're buying here "for the long haul" you are attempting to front-run a trend change that would be years away and another 50% - or more - below us in terms of price. This market is not a falling knife - it is a falling chainsaw.

In short, essentially nothing positive has been done and a lot of damage has been inflicted on everyone in America out of hubris, fraud and avarice.

We now are "discovering" what I have written about for more than a year first-hand - the so-called "growth" over the last seven years has all been a fraud, instead being nothing more than additional debt. Ponzi-finance has taken over every area of our economy, from government to private business, and has run to the natural limit of "the greater sucker", now leaving all of the people beguiled and bedeviled exposed as the naked-swimmers that they are.

There has been zero push for accountability and truth throughout the system. Not among our so-called "leaders", not among the bankers, not among the political or economic elite. All are focused on trying to keep the impossible going.

The truth of all of this is trivially easy for you to demonstrate to yourself. Just ask the following questions:

If you have $100,000 and borrow another $100,000, have you doubled your net worth, or have you actually harmed your economic position, as you will not only have to pay back the $100,000 you borrowed but also interest on that money?
If you do not own a home, do you want that house to be priced high or low?
If you want to buy a car, do you want the price on the car to be $20,000 or $40,000?
If you're buying gasoline do you want it to cost $2 or $5 a gallon?
Are you better off with zero credit card debt, $2,000 in credit card debt or $20,000 in credit card debt?
How did we actually nominate a man for President of the United States (he lost by the way) who declared publicly that he had one half million dollars in credit card debt and couldn't tell a reporter how many houses he owned?
How did we have a bill, the EESA/TARP that obligated citizens to pay $700 billion in taxes that we do not have (that is, to put us all in debt by another $700 billion), that was opposed from 100:1 to 300:1 in calls, faxes and letters to Congress, was passed over those objections with an election less than a month away, and we the people then returned 90% of those who voted "Yes" and stood for re-election to office?

There will be no improvement in the economic condition of our nation until each and every one of us ask ourselves these questions, honestly contemplate our answers, and then put our outrage (or desire) for those economic conditions into firm, no-nonsense peaceful action to force our elected and unelected government officials to act as we direct.

Please realize that if just one third of one percent of the population of America was to get upset enough with the blatant fraud, theft, Racketeering and Ponzi Finance that has literally decimated the economic structure of our nation, American households and our future (not to mention our children) and were to show up in Washington DC in peaceful protest, occupying The Mall, Constitution Avenue and surrounding areas and refused to leave until every one of these charlatans resigned in disgrace or committed seppuka on national TV the protesters would number one million.

Such a mass of people would be literally impossible to refuse to answer to. That we have not yet seen it simply means that the population of this nation either doesn't care that it is being systematically looted, is too full of Prozac to pay attention to the racketeering and theft or is simply not paying attention. (My vote, by the way, goes to the latter - at least for now.)

Further, if we the people were to organize as few as one hundred individuals in each major city we could effectively slow commerce to the point that it would break down entirely, all through peaceful means.

How? Envision your local freeway; you, and three of your friends (four lanes each way, four drivers) line up parallel and then slow to a crawl (if you're in "rush hour" traffic) or to 20mph if not. Traffic would instantaneously snarl behind you and remain that way for hours. Your risk? A traffic ticket. A few hundred dedicated people in each major city could very effectively demand that real reform take place and that all the fraudsters go to jail, refusing to stop their daily protest until it was done. Again - a tiny fraction of one percent of the population of this nation could, through entirely-peaceful actions in protest, force a stop to this nonsense.

It hasn't happened. Why not? Are there not a few hundred unemployed as a consequence of this fraud in every major city across America? Are we really all so neutered as Americans that we will refuse to peacefully protest in an effective manner?

You want to know why the fraudsters - including everyone screaming to be bailed out of their ill-conceived schemes - are winning?

It is because Americans refuse to get off their ass, even though very effective and fully-peaceful means of demonstrating and demanding change - Constitutionally Protected means of expression that would have vast and immediate effect - exist.

Simply put, we are consenting as individuals and a nation to the economic rape being served upon us by the scams and schemes of the few.

Now let's look at first principles when it comes to economics. All of these are not desires, wishes or dreams - they are facts:

Debt when used to "pull forward" future production into current spending can be useful (for example, the farmer who borrows to buy seed or the producer of goods who borrows to buy raw materials that then are made into finished goods.) Debt taken to finance consumption has zero positive long-term impact on the economy. When debt is taken to pay existing debt it has the potential to result in catastrophic economic collapse. The latter is what we have been doing for the last 30 years.
You cannot solve an addiction problem with more of whatever the addict is hooked on, whether it be booze, crack, meth - or debt.
Its not credit, its debt. Stop listening to the BS handed out on CNBC and in the paper. When someone you talk to says "credit" stop them right there and correct them.
Our monetary system is debt based. The more "liquidity" they pump (and even the more money they "print") the more debt is taken on. Again - have you ever seen an addict cured by giving them more of their favored drug? Is there any possibility that this "medicine" can actually work? Simply put: NO.
Debt is inherently deflationary. The inflationary impact of additional credit creation is temporary; in the longer run debt always has a deflationary impact. This is obvious and inescapable if you use your head; since debt must be repaid with interest, it therefore most deflate (decrease) the monetary base since interest is a non-productive "charge" against income and (thus) earnings. This, by the way, is the fatal flaw in Bernanke's Doctoral Thesis; by refusing to recognize that all modern monetary systems (including ours) are debt-based he also fails to recognize that there are limits to being able to "print" your way out of a deflation since what you are printing is in fact debt and eventually you reach an "inflection point" where the spiral tightens - that is, the more "printing" you do the worse the problem gets!
If debt as a percentage of GDP is increasing then you are paying off debt with more debt and falsely stating GDP. This is obvious to any objective observer; a debt taken to buy a car shows up in "GDP" as the car must be produced but in fact the actual GDP impact of that transaction (over time) is negative as interest must be paid on the debt and the principal must be paid down. In the converse if debt-to-GDP is shrinking then GDP is understated. The true GDP number is only presented when the debt-to-GDP percentage is stable. This is true for all debt-based monetary systems and cannot be changed by waving around magic Federal Reserve wands.
We have been falsely claiming "growth" that did not actually occur for more than 20 years; this is why your wages have been stagnant while everything you need to buy has gone up in price and for most Americans their standard of living has contracted.

The above will not change until the Debt-To-GDP ratio begins to drop.

That cannot happen until The Government stops supporting the bankrupt with more and more bailouts and "stimulus" and instead forces those who can pay down their debt to do so along with forcing those who can't (the broke) into bankruptcy court where their debt is discharged.

The economic pain inherent in such a process cannot be avoided, it can only be delayed and with each delay the total damage that must be absorbed to restore balance to the economy grows.

We keep hearing so-called "pundits" talk about how "we must spend like mad or we will have a Depression." Folks, that die was cast in 2001 when the decision to avoid a recession by pulling forward demand through excessive debt. It is no longer possible to avoid the outcome, we can only choose when the outcome occurs, and the longer we wait to do it the worse it will be as a direct consequence of the fact that in all modern monetary systems money issued by the government is in fact debt and the problem is that we have too much debt already!

FDR has been widely hailed as a hero. He was no such thing. FDR's policies in fact caused a second wave of depression after the original downdraft that originated in 1929. This is not commonly reported but it is in fact true - there was a second, nearly 20% contraction in GDP that occurred as a direct consequence of FDR's policies. Repeating what FDR did to any material degree will not help, and any apparent "relief" will be false.

In short, as pointed out in The Ticker of the 20th - We are all Madoff in one form or another.

Ok, so with that cheery backdrop, here you go with my predictions for 2009.... and I will prefix this by saying this is a list I hope proves to be entirely incorrect. Perhaps there really is a Unicorn that craps skittles even though I've yet to find it - this is one round of predictions I'm willing to take a zero score on come December 09.

The economy will not recover in 2009. Job loss will continue through the year and unemployment will reach 8% in the "headline" statistic by the end of the year. U-6 (broad unemployment, or the closest to "real" unemployment without government "cooking") will top 15%. All the "talking heads" are predicting a turnaround in the second half of 2009. They will be wrong. Look at their records for 2008 - all of them were predicting closes at or above 1500 for the S&P 500. Why does CNBC continue to put people on the air who, if you listened to them, cost you 40% or more of your money?
Deflation, not inflation, will become evident well beyond housing. Other capital goods beyond housing will see real price declines for the first time since the 1930s. Debt is inherently deflationary; the "hyperinflationists" will once again be shown to be wrong (how many years running will it be now?)
Housing prices will continue to decline. I believe we're about halfway done with the price correction. Those who think we will turn this in 2009 are wrong - unless we get an all-on collapse in prices in early 2009, which I do not believe will occur. I've heard several claims we will have positive year-over-year home price changes in 2009. I'll take the other side of that bet.
The Fed's attempt to "pump liquidity" will be shown to be an abject failure. We will see either a Treasury Market selloff or worse, severe instability in the dollar at some point in 2009.
GDP will post a 12-month negative number and there is a decent shot that we will actually see an official depression print before the end of 2009, defined as a 10% decline peak-to-trough.
The Stock Market has not bottomed although you may think it has for a few months. The annual range will be quite extreme; I would not be surprised at all to see 1,000 touched on the SPX in the first part of the year. I believe the SPX will at least touch 500 in the next 12-24 months and the current bottom will not hold. It is possible that we could see a crash to SPX 300 and DOW 3,000 some time this year, probably after the spring (when the "Obama Halo" wears off - if it isn't blown off by economic events first.) Yes, this means I am predicting a fifty percent swing in the SPX in 2009. Lots of money to be made as a trader if you're quick and good, but an absolute minefield if you're a long-term investor.
Precious metals will not be a safe haven. The callers for $1600 and above on gold will be wrong, unless there is a major military conflict. I do not rate that probability as particularly high, but it is an event (along with a major terrorism incident - nuclear or biochemical - that would cause a rocket shot in Gold prices), so I am hedging that call. The risk of this sort of "response" to the economic crisis is, however, real, and will rise significantly going into 2010 and beyond. We'll revisit this one (a major war) next year.
The Dollar will not collapse. This is not because we're in great shape or will truly recover, it is because the rest of the world is in worse shape than we are. Last year pundits were all calling for the dollar to collapse to 40 - it didn't happen. Now they're calling the dollar's strength a "Bear market rally." Nonsense; the simple truth is that while we're in bad shape the rest of the world is literally on the precipice of a full-on collapse. European banks are more-levered and less-transparent than our banks as just one example.
The pound or euro - and perhaps both - will likely be where the FX dislocation initiates if it occurs. I see the potential for the pound and euro to both reach par with the dollar, although I'm not going to go that far out on the tree limb and predict it - yet. Needless to say that would rocket the Dollar Index but it won't be our strength that does it - it will be their weakness.
The US Consumer will go from a negative savings rate to a seriously-positive one. I am predicting 4% in 2009 but it could go as high as 10%. The math on this is simple - the "consumerist legion of more" has run its course and all that's left is debt. It hurts and bad; expecting the American Consumer to cut off his other arm is just plain dumb. By the way this is a good thing in the longer term for America once the excess debt is forced out and defaulted through the system.
Commercial Real Estate will effectively collapse and most commercial Real Estate REITs will be either insolvent or limping on life support. There will be calls for bailouts (which may be attempted; the calls are already starting to be heard) but it won't matter - a failed business is a failed business, bailout or no, and overcapacity must go away before sustainable business conditions can return.
Along with the above, expect 10% of all retail stores to close, and that number could go as high as 20%. That's not going to be fun; there will be hundreds of malls that wind up literally shuttered across America. Stay away from most retailers and property groups as investments. Firms like SPG and VNO are levitating on the strength of their dividends (7-10% yields at present); I believe this is a sucker play; if retailer defaults force dividend cuts (and I believe they will) the commercial REITs will go straight into the toilet.
Several states will get in serious financial trouble and outright default of one or more is possible in 2009. California leads this parade. But even if there is a default on a state basis, the effect will be highly localized, as county and municipal governments vary in their wisdom and budget process. The real pain comes in state-wide social and educational programs. Be very careful if you are in municipal bonds or thinking of getting back into them (I recommended they be dumped in 2007 - look at what has happened ot the closed-end funds in 08! Aieeee!) as the default risk is VERY REAL. If you're buying individual issues and do the work to determine not only the risk of default but also the likely recovery if they do default there are some good deals out there - but only if you're doing the work. "Trust me" (as in buying funds, whether mutual funds or closed-end stuff) is very dangerous.
Mortgages are not done. The story last year was "Subprime." This year's will be "ALT-A", "Option ARMs" and so-called "Prime". The Fed and Treasury know this, which is why they are playing games with "agency" debt in a desperate attempt to clear this market before the ticking nuclear devices go off. The amount of debt involved in these "bad deals" is vastly higher than that in the "subprime" space and if they fail to contain it (a near certainty) Round #2 of severe bank instability gets served up on us in the second half of 2009.
If you want to refinance a mortgage you may get one brief shot at it with long rates around 4%. You're nuts to buy outright unless you intend to die in the home, but if you have a solid reason to be obtaining a mortgage or wish to refinance you will probably get the opportunity. This assumes the "buydown game" gets going before Treasuries dislocate; if you get the opportunity take it as it is likely to be fleeting. The few places in this country where homes wind up selling for 2.5x incomes (on average) and you have an opportunity to finance at 4% and change will be decent buying opportunities - if you're sure you can cash flow the note (e.g. your job and/or income stream is not in any danger of collapsing.)
Those who have said that the corporate bond market is being "unreasonable" in its expectation for defaults will start to look like the jackasses they are. Actual default rates (not projections) on non-investment-grade debt will skyrocket starting in 2009 and there will be no sign of it turning around this year. If you're playing in this area of the market thinking that "the worst is behind us", I hope you like walking around bald as the haircuts handed out to folks like you will be especially severe and delivered with a straight razor.
The calls for "more lending" to consumers and businesses will go exactly nowhere. The problem isn't credit availability - there's plenty of money available to lend if you are credit-worthy. Those who are being turned down now simply aren't credit-worthy when one looks at what they want to do with the money and what they're backing their repayment capacity with. The more "credit stimulus" is thrown into the economy (and there will be more) the worse the downturn will get.
General Motors and Chrysler will fail to meet their targets and it will be labor that sinks the deal. At least one and probably both will wind up in some form of bankruptcy in 2009. The UAW is insane; Gettlefinger needs to be strung up by his genitals and pelted with rotten tomatoes by his union "brothers", and if they had a lick of sense they'd have already done it. They obviously don't. I give this mess six months tops, with Ford as the only possible survivor. The recent GMAC games show exactly how desperate they are; 0% 5 year loans to people with 620 FICO scores are flat-out insane and the default rates on those loans are going to wind up in economics textbooks five years hence.
Protectionism and currency manipulation will rear their ugly heads in 2009, originating not here but in Asia as their economies go straight into the toilet. China and Japan are at severe risk here.
Commodities will appear to be headed for a new bull market but this will turn out to be a false hope as demand continues to collapse. Attempts to manage oil output to prop up the price will fail. Several oil-producing nations will find themselves in serious economic trouble, with Russia being in the lead but by no means alone.
Sovereign debt defaults will number at least three with many other nations on "watch" for same; we had one last year (Iceland.) Noise about a US "AAA" downgrade will continue. Highest on the list for probables are Russia, which needs oil at roughly double its current price - and stable - to be financially viable. Not going to happen in the near term.
China will have its first large-scale rumbling of civil unrest as a consequence of collapsing export demand and thus employment. They'll manage to tamp it down - this year. Don't take a bet on that holding together longer-term. Those who think China will be "ok" are deluded; they have a horrifying overcapacity problem (debt-financed, of course) and there is no way for them to get out of it. They are truly going to "take it in both holes" down the road, but the worst of it won't be in 2009 - that is still a year or two in the future.
Foreign uptake of Treasuries will be choked off - by necessity. It won't be because they want to screw the US (although they should have a long time ago, given our profligate and unsustainable habits), it will be because they will be forced to redirect their resources inward as their own economies collapse.
"The City" (London to be precise, Britain generally) will be recognized as getting it "worse than we are" (in America.) This will be the first of many validations of my thesis "we're screwed, they're gang-raped."
Things will get "revolting" in a number of nations. Not here in America. Yet. If we're lucky the American Sheep will wake up and stage some of that peaceful protest stuff I outlined above. If we're not so fortunate 2010 could be really bad.

In terms of recommendations its simple - rallies are to be sold, cash is to be raised and prudence is to be practiced in your own personal financial affairs. Don't get creative in all things finance, get stingy and prudent. Your personal financial survival could well depend on it.

We're All Madoff

nospam@example.com (Karl Denninger) — Sat, 20 Dec 2008 15:44:41 -0500

This is an uncomfortable reality, but it is reality.

Mr. Madoff stands accused of (in his own words) running "a Ponzi Scheme."

In fact, our entire economy over the last ten years, and really back to at least 1987, has been roughly equivalent to what Mr. Madoff was doing.

So has our government.

Let's go down the list of things that have been inflated beyond their natural boundaries, and look at how each and every one of them was destined to collapse - and why they're all collapsing at once:

The Internet Bubble. While there were companies that made a real pre-tax operating profit (and a real net profit), mine included, the vast majority of the firms in the Internet space did no such thing. They reported "pro-forma" earnings, used EBIDTA (that's earnings before interest, depreciation, taxation and amortization, as if none of those things count) while levering up (meaning: interest was going to continue to rise!) as their primary profit gauge, and in fact operated with leverage ratios (total assets deployed to tangible equity - that is, value) that were in the stratosphere. In short they borrowed to pay back their previous loans and make payroll, and when the lenders (which were in some cases equipment manufacturers) realized that they'd been had, the entire house of cards came tumbling down.
The Housing Bubble. Homes, as a place to live, must be able to be purchased for a reasonable percentage of one's income. What's "reasonable"? History says that this is 28% of your pretax income for all your direct household expenses (principal, interest, taxes and insurance plus mandatory spending such as utilities and a maintenance reserve) and 36% of your pretax income for all debt service including household and other. Note that at the "maximum leverage" that is sustainable you have only 8% of your pretax income available for "other debt service"; how many people can meet that? Think folks - if you have a $100,000 income, this means you have only eight thousand dollars for all payments on other debt. Two modest car loans and their insurance will exceed this limit for someone who makes $100,000 - and we're talking Ford's here (small sedans too, not SUVs), not Benz's or Lexii. As these ratios were exceeded in order to remain "affordable" increasingly exotic terms were required, starting back in 2001 when the car makers were cajoled by the Bush Administration to put forward their "Drive America" program with zero-percent interest for three years. As this crept further and further into our economy mortgage programs that were in fact not mortgages (as there was absolutely no possibility of the borrower paying them off on the original terms) were pushed in order to keep property values climbing. In 2007 the limit of this insanity was reached, the "last sucker" was found, and the pyramid collapsed as these so-called "mortgages" were exposed for what they really were - a serial-refinancing scheme designed to strip equity and transfer it to the bankers. The entire scheme collapsed and along with it our markets and economy.
The Stock and Credit Markets Generally. The Internet Bubble and Housing Bubble were the externally-visible symptoms of what was going on behind the scenes. The S&P 500 was posting "earnings" of more than $100 a share, but those "earnings" were a phantom. "Private Equity" and "Hedge Funds" were buying companies and essentially flipping them using debt backed by bank credit that was, like in the housing and Internet markets, backed by nothing other than vapor. Commercial Real Estate deals were being done at "cap rates" that were unbelievably optimistic, essentially not even paying the interest due, banking on the ability to roll the debt as "property values never go down." Anyone remember "M&A Monday" on CNBC through all of 2006 and the spring and summer of 2007? What was that all about, if not flipping companies like speculators flipped houses?
Our Government's Finances. We put into place Social Security and Medicare, two schemes that have accumulated fifty three trillion dollars in forward liabilities with zero in assets behind them. These liabilities are growing at a rate several times that of GDP. Then, as if this wasn't enough, we passed "Medicare Part D" which has now added even more to the liability side of the balance sheet but which was and is totally unfunded by assets. This both can and will collapse just as did the Housing and Internet bubbles. Our government has been spending money it doesn't (and never will) have for a very long time, but we have now entered the phase (just like the Internet and Housing Bubbles) where debt is increasing at an exponential rate compared to assets. We have, in the last year, nearly doubled the outstanding public debt commitments on the United States ($8 trillion added against a $10 trillion base), with the previous $10 trillion itself having doubled from $5 trillion in the space of just a bit more than a decade.

There are many who say that our government debt-bubble will not collapse, and they list a whole host of reasons.

Why would you believe that?

Can you show, through history, one speculative bubble that has not popped?

Can you find one time - just once - that such a bubble was able to be grown without limit?

Simply put: No.

Americans have, as a nation, become fat, dumb, "entitled" and lazy.

Our Declaration of Independence lists the following rights that are endowed to us by our creator:

Life, Liberty and the pursuit of Happiness.

Note that nowhere in this list are:

Free anything, including wealth, food, health care, shelter or even a job.
Happiness itself (only the right to pursue, but not achieve, happiness is endowed)

America as a nation was founded by a group of rugged individuals who understood all of this. They were not necessarily religious, although they believed in divine providence; that is, that "from somewhere more powerful than they their original seed was formed." Some believed that source was a Christian God, some believed it to be the earth herself, some believed it to be some vague spiritual force.

But all believed and understood that the fundamental rights that flowed from that original creation did not involve deceit, trickery or theft, irrespective of how it was accomplished.

Unfortunately deceit, trickery and theft all feed on themselves. They are uniquely human vices; when they first appear they seem innocuous. "Social Security" was originally called "OASDI" (that is, Old Age, Survivors and Disability Insurance) and still legally is. Think about that for a minute - two of the components were put into that bill to guarantee that children would not starve, and those who became permanently disabled (usually through work) would not be cast into the streets to die. A noble cause to be sure, but what has Social Security become? While the "SDI" portions still remain and are both important and, one would argue, necessary, that's not where all the money goes - it goes instead to the "Old Age" portion, where nearly everyone who receives it made choices during their working years to spend all, or nearly all, of their earnings.

There are many who argue that those who live "hand to mouth" don't have that choice. Really? Here are two statistics that make clear that this is simply false:

In 2003 there were 159 million cell phone subscribers in the United States, and the average monthly bill was $49.91. Penetration has since grown to approximately 70% of the population (from ~60% in 2003.) Since 25% of all persons are under the age of 18, the majority of the non-subscribers to cellular services are in fact children under the age of 10.
In 2002 58 percent of persons age 18 and over were overweight, and 23 percent were considered medically obese.

So in fact we have two "inconvenient facts" that contradict the claim that those who live "hand to mouth" and yet are working could not save for their retirement and old age if they decided to do so - the first being that they spend nearly $600 a year on cellular service - a luxury, and the second being that nearly 6 in 10 are consuming significantly more food (and paying for it) than their body demands for metabolic balance.

This sort of "self-deceit" is how it begins. You're now considered "poor" if you live in a 1300 square foot house and don't have a cellphone.

Yet in the 1960s and 70s, decidedly-middle-class Americans - myself included - grew up in homes like this that featured three small bedrooms, one bathroom, one living room of about 150 square feet and an eat-in kitchen. We had one black and white television in the living room with rabbit ears on top and one telephone on the wall, and we could not afford to make long-distance phone calls with the exception of a couple of very short calls to relatives over the Holidays. We did not have air conditioning nor all manner of electronics chewing at electricity day in and out and thus our electrical consumption was a fraction (in kilowatt-hours) of what people consume now. McDonalds' was considered a luxury, as it was (and is) cheaper to cook up something at home - say much less other restaurants.
My father was a CPA for Howe-Martz Glass in Detroit during most of my youth - a decidedly middle-class, white-collar career.
Today, the way we lived would be mocked as "destitute."

Don't get me wrong - improving standards of living are not a bad thing. In fact, they're a very good thing, and we have come a long way since 1776 in that regard. Indoor plumbing, flush toilets, electrification of homes allowing lighting and machinery, telephones, personal computers, the Internet and the automobile (and its larger cousin the truck) all have brought great strides forward in our society.

But somewhere along the line we decided that transparency in our financial dealings, both as a government and privately, were not essential elements of fair dealing and computation of risk.

And therein lies the problem.

See, evil requires secrecy.

Theoretically, banks are supposed to hold reserves of about 8% against their deposits, and therefore are limited to roughly 12:1 leverage against their asset base. Investment banks had a similar limit explicitly codified in the law, because as non-depository institutions they had no deposits against which to measure these ratios. In fact, up until 1998, all such "demand accounts" - that is, those in which you could walk into the bank and demand your money immediately (e.g. checking accounts and similar) were subject to these reserve requirements. This put an effective cap on leverage and thus risk - and the otherwise-unbridled growth of commercial and bank credit.

But starting in 1998 this changed. This Treasury Department OTS memorandum outlines a number of bills that were put forward by Senators and Representatives that, in many cases, still sit in our Congress. Senators Shelby, Hagel and Reid are explicitly named, along with the infamous Representative Leach of Gramm-Leach-Bliley. That memorandum also effectively eviscerated the reserve requirements that formerly kept our banking and thrift system safe and sound.

Between this change in policy, The Federal Reserve's intentional refusal to act to stop what amounted to infinite leverage, Treasury Secretary Paulson's (successful) entreaty to ease leverage limits on investment banks in 2004 (when he was running Goldman Sachs) and other similar actions taken by our government, we have in fact created the largest bubble ever blown in economic history throughout our banking and credit systems.

Now that bubble has popped.

In 2000, the damage done by the 1998 and 1999 decisions (which just happened to coincide with the final "blow off" top in the Nasdaq!) put our GDP approximately 10% "out of balance" with our actual productive capacity.

That is, the debt taken on during that bubble in excess of GDP growth represented about a 10% "premium" to a sustainable GDP level. Were we to simply wave a wand and make that debt (credit) disappear, GDP would have been 10% below where it was in 2000.

2000 GDP was approximately $10 trillion, so we would have suffered a $1 trillion contraction in GDP to bring the system back into balance, along with whatever business and banking failures which would have come along with that adjustment. Those failures would have resulted in an "overshoot" of some amount - perhaps another $500 billion.

Note that a total "peak to trough" contraction of 10% is generally thought of as a Depression. Not a "Great Depression", but an "ordinary" Depression.

Therefore, the economy in 2000 faced an economic Depression. To put this in perspective, in the post-war era the worst Recession on record was the 1973-75 event which recorded a 4.9% contraction in real GDP.

George Bush, our Congress and Alan Greenspan, however, refused to accept their responsibility in 2000 and 2001 for the economic policies of this nation and its banking regulators that led to the final blow-off top in the Internet Bubble.

In fact, Gramm-Leach-Bliley along with the sweep account changes were responsible for about half of the excess leverage of the Internet Bubble, and thus about half of the economic correction made necessary by its final blow-off top.

That's right - had those changes not been made we would have faced a 1973-74 style recession, but with those changes we were guaranteed a depression as the economic "just desserts" of the Internet Bubble era.

Being that this was deemed "unacceptable" Alan Greenspan along with Congress and the other regulatory bodies in Washington DC responsible for banking (and general credit system) safety and soundness undertook an intentional course of action to "paper over" the losses.

But wait! How can you do that?

You can't - except through fraud.

That is, you cannot prevent a loss from appearing and being recognized unless you allow people to lie about the value of securities, place them off-balance-sheet in opaque containers where nobody can see what's inside (and thus how they're performing) and "lever up" to issue yet more debt (credit) to cover the cash flow that should be happening but isn't.

As the embedded (and fraudulently-concealed) debt continued to mount banks and other institutions found themselves performing a Madoff - that is, issuing new credit (debt) to be able to "show earnings" that in fact were a phantom. Unlike Madoff they did not have to go find someone new to put money in to be able to issue the checks to existing investors, since a bank that can operate with no reserve requirements imposed on it is capable of issuing as much credit as it wants, effectively "printing money."

Regulations and leverage limits are supposed to prevent this, but they were systematically and intentionally dismantled in the name of "financial innovation."

In truth they were dismantled in the name of a massive financial fraud that permeated every corner of our credit system, from credit cards to student loans to automobiles to housing.

Every organ of our government and regulatory system was involved in this knowing deceit - Congress, The White House, Treasury, The Federal Reserve - and still is.

So why did the bubble collapse, if these institutions are able to continue to literally "print money" and the regulators were intentionally ignoring all of it?

The fundamental problem with all Ponzi Schemes, even those in which the operator is able to issue credit at will, is that it relies on people not challenging the books.

It requires "belief" - that is, confidence.

Thus the phrase "con game".

When Bear Stearns two hedge funds collapsed, the house of cards began to shake. People started looking at balance sheets and asking lots of very inconvenient questions, including exactly how one can have a mortgage-backed security rated "AAA" when 40% of the loans in it are either delinquent or in foreclosure. A few people started to listen to those who had analyzed the math, such as myself and Mish, and the light came on in their head - "Oh My God, they're right!"

See, while credit spends like money, it is not money.

Money is in fact production; you gain it only three ways - by growing something, mining something or making something. That is, by producing a thing (whether it be a car, apples, a barrel of oil or software) that did not exist before. In the most-basic of terms, all money ultimately comes from the energy imparted upon the earth by the Sun.

Yet money backs all credit at some ratio, and the higher the ratio, the more that credit is subject to destruction if those people with money (that is, production) decide to take their ball and go home.

This, at its root, is why all schemes like this must and will fail. It is a mathematical certainty that confidence will eventually be lost as the math and truth of what is going on will eventually become evident to a sufficient number of producers and they will "take their ball home"; once that happens the credit they are underwriting is no longer backed by production. This leads to a rapidly-increasing leverage ratio which in turn leads even more people to "take their ball home" and the scheme thus must and does collapse.

You would think that Bernanke and Paulson would recognize what is going on - and that they are unable to stop the inevitable collapse.

Here's the problem - they do recognize it, but they are two of the architects of it, and admitting the truth means taking responsibility for what they have done.

That's not going to happen so long as they believe they can manage to keep the "con" going with someone.

The group of "someone's", however, is shrinking rapidly. Commercial and Investment bank loans, then Fannie and Freddie, then commercial paper issuers, and now various sorts of consumer loan products such as credit cards, automobile financing and student loans are all being shunned by those with actual money as they start to peek under the kimono and find not a pleasant sight but rather something both ugly and hairy staring back at them.

Thus, the transfer of all of this "credit" (really bad debt) no longer backed by money (as the producers have taken their ball and left) from the institutions that created the ponzi scheme to "the sovereign" - the Government - in all of its forms, whether it be Treasury or The Fed directly.

The latest announcement came on Friday, when The Fed loosened the terms of the TALF (one of its alphabet soup programs) and effectively allowed hedge funds to borrow from it.

This, incidentally, is why Bloomberg has had to sue The Fed to try to get disclosure of the crap they have taken on their balance sheet, and why Fox News announced that it is suing Treasury to gain disclosure of what they have taken on.

It is also why Markit has announced that they're "postponing" the listing of performance data on "Prime" mortgages - they were pressured to do so (by their own admission) because a published price means no more lying about values, and that could mean immediate (and monstrous) new writedowns for banks which hold trillions of dollars of "Prime" mortgages yet are valuing them pretty much "however they want."

As I said before, evil requires secrecy.

There is real (and justified) fear that should the truth of what is being held in these "Fed and Treasury programs" be disclosed in full that those with money (that is, producers) would flee United States Treasuries (and dollars.)

This is not an unjustified fear; it is, in fact, fear of exactly what has happened thus far and led to the collapse of AIG, Lehman, Bear Sterns and the near-collapse of Fannie and Freddie.

And what is The Fed using for its "credit grade"? Ratings from the same agencies that graded as "AAA" toxic subprime debt that all blew up.

If this last gambit fails so does our government's ability to deficit spend.

There is a near-100% probability that it will fail - we are simply arguing about the "when", not the "if".

See, without evidence that the debt (not deficit) they are asked to back will be paid down at some date-reasonable in the future, eventually the people with money will flee.

It is simply a matter of exactly when their confidence fails (that is, at what leverage ratio do they say "screw this!"), not if it will fail.

Removal of the ability to deficit spend, when the government will be running a $1 trillion+ deficit next year, would result in a roughly 25% instantaneous reduction in the government's budget - assuming tax receipts will be maintained. The problem is that they won't - with unemployment skyrocketing and GDP collapsing, tax receipts are likely to fall 30% or more, meaning that in all probability the government will find itself having to cut its budget in half on an immediate basis.

Since a goodly part of that budget is in fact interest and it cannot be cut (without causing a general default) the consequence would be a requirement to slash all government programs immediately by approximately 60% - including Medicare, Social Security, the military, education, other social programs (e.g. Title I) and everything else. In addition The Fed would be forced to immediately disgorge all of its bad assets into the market at whatever price they could be sold for, lest The Dollar become "de-currencied" almost instantaneously.

Think about Iceland and how quickly their situation unraveled. It can - and may - happen here.

Now to the next question - how bad would it be if we were to take the proper steps today to bring our economy back into balance? And how bad will it be if we wait a while longer, and/or are forced to do so by a confidence problem with our government debt and/or currency?

To bring our economy back into balance, as of August 2007, we would have required a 20% GDP correction as a direct consequence of the actions of the 2000-2007 time frame. While this is "twice as bad as 2000" in terms of percentages, it is actually three times as bad in terms of dollars, since GDP went from $10 - $14 trillion during those years.

That is, as of August 2007, we would have had to suffer a $3 trillion contraction in GDP, essentially wiping out all of the gains since 2000.

In the last year we have spent - not committed, spent - another $2 trillion dollars we do not have. That is another 10% GDP contraction, for a total of 30% - or roughly equivalent to the Great Depression.

This increase in the severity of the necessary re-balancing of the economy was brought about as a direct result of the actions of Ben Bernanke, Hank Paulson and Congress. That's right - fully 1/3rd of the damage that now must be taken was voluntarily taken on and put on your head in the last year by the people who claim they are "protecting" the American economy.

If we allow the programs promised thus far - totaling $8 trillion - to be spent, plus Obama's expected $700 billion+ "stimulus" package to be put into the mix, we will get very close to and may exceed 50% GDP contraction required to bring the economy back into balance. That is, the total damage will be five times that which was necessary in 2000 and more than twice that necessary in August of 2007, and all of that increase will be due to the intentional acts of our government officials.

I have high confidence that we won't get to that level of destruction simply because the producers with money won't allow it to go that far before they pull the rug out from under us.

I rate the odds of a forced cessation of these programs, either via a bond market dislocation or a currency crisis somewhere before that $8+ trillion number is realized in excess of 80%.

The important thing to keep in mind is that the sooner we stop this idiocy the less damage we will take.

That the damage will be serious, that unemployment will be rampant, that our economy will contract dramatically - this is now all assured and cannot be avoided.

But the more money we spend that we do not have, and the more risk we transfer to our nation's balance sheet (instead of leaving it where it is and allowing it to sink the imprudent) the worse the inevitable will become.

We are buying rapidly-decreasing amounts of time before the dislocation and dramatically increasing the amount of damage that will occur with our present policies.

This is mathematics, not conjecture, and irrespective of the government's attempt to claim otherwise 2 + 2 still equals 4.

Finally, before one says that "FDR did this and it helped" in the 1930s note that the "Great Depression" was actually two separate events, with the first (1929 - 1933) being a contraction of about 33%, and the second, from 1937 to 1938 where GDP declined by 18.2%.

The second contraction was entirely caused by the government's response to The Depression (and The Depression itself was caused by government's refusal to perform its regulatory role!), and it was only WWII that truly put a stop to it by killing off competition for jobs and destroying huge amounts of capital equipment that then had to be replaced.

Unless you're rooting for several million of our young people to be killed in the next World War, this lunacy must stop now.

LA LA LA LA LA LA LA LA

nospam@example.com (Karl Denninger) — Sat, 13 Dec 2008 18:57:00 -0500

That's the sound of someone with their fingers in their ears making noise so they don't have to listen to the person talking in front of them.

The list includes:

Congress - warned explicitly in 1991 that repeal of Glass-Steagall was a bad idea and would lead to exactly what we're seeing now. LALALALALA.
Congress (again) - warned repeatedly by the SEC in 2000 that removing caps on leverage (Requested by none other than Henry Paulson!) was demonstrably unsound (by the SEC of the time) - LALALALALALA.
The SEC - warned about Madroff by Harry Markopolos - in writing - that Madroff was the world's largest Ponzi Scheme. LALALALALALALA.
Alan Greenpan's fantasies were ignored by Congress and still are. But he did tell people what he was going to do and was up to in trying to thwart a mathematical long-wave cycle (Kondratieff Winter) and also stated that if he failed, what would occur would make The Depression look like "A Sunday-school picnic." LALALALALALALALA.
The FBI and Congress (again) - there were petitions sent to Congress on behalf of thousands of property appraisers as far back as 2001 noting the pressure to falsify numbers. LALALALALALALA.
Treasury and The Federal Reserve - the debt-to-GDP numbers are right in their face (hell, they report most of the base data!) but they think they can keep taking on debt to "solve" a solvency problem. LALALALALALALALA.
US Consumers - There are only two ways to fix their balance sheets - sell the assets on which the debt is carried and pay it off or spend less than you earn. There is no third choice. LALALALALALALALA.
Congress (again) - Bernanke and Paulson ("Subprime is contained", "We are not and will not go into recession", "The economy is fundamentally sound", etc etc etc.) Accountability for what are now known to be clear lies? LALALALALALALALA.
Regulators in the R/E industry of all stripes - LandAmerica, a big title insurance company, has filed for bankruptcy. Why? Because instead of actually performing title searches title companies have been outsourcing the work to foreigners in places like India, where the so-called "search" has turned into nothing more than a quick dig through electronic records. Of course when there are real claims on the title the company is then on the hook and can't pay; instant boom! Where is the investigation of this obvious misrepresentation of what the purchaser of that policy bought? LALALALALALALALALALA.
Obama still seems to think he can "soften the blow" by spending a trillion more (that we don't have.) He obviously hasn't bothered paying attention to the debt-to-GDP numbers, or to what happened in the 1930s as GDP fell away. This plan, if implemented, will give it to us in both holes as GDP will fall at the precise same time that debt increases. LALALALALALALALALA.
Californicated is running a monster deficit and threatening to implode. Republicans are refusing to raise taxes while Democrats are refusing to cut spending. Neither party pays any attention to the fact that the state has been spending money that doesn't really exist (as a consequence of the housing bubble) on illegal immigrants from various social programs to schooling to jailing illegals instead of shipping them all home. As with the rest of the states, they spent all of the money during the flush years, and are now in serious trouble. LA LA LA LA LA LA.
The Fed, Treasury and Congress all have known for years about the fact that banks were making bad loans that had no chance of being paid. The warnings were copious and unending. LALALALALALALALALA.
Congress (again) still refuses to force financial institutions to state their actual, real, total exposure to bad debt, bring everything back onto balance sheets and stop marking to fantasy. Yes, that would mean we'd all get to see the bankruptcies in front of us. Its easier to stick your head in the sand. LALALALALALALALALA.

There's lots more but I think you get the point. If you still are having trouble figuring it out, here 'ya go - a picture is worth 1000 words.

More Media LIES

nospam@example.com (Karl Denninger) — Thu, 11 Dec 2008 11:59:00 -0500

Will it ever end?

"Stung by the loss of $2.81 trillion in their net wealth, U.S. households paid down their debts in the third quarter for the first time since at least 1952, the Federal Reserve reported Thursday. As of Sept. 30, households' total outstanding debt shrank at an annual rate of 0.8% from $13.94 trillion to $13.91 trillion, the Fed said in its quarterly flow of funds report"

No they didn't.

What really happened is that households defaulted on mortgages at an increasing rate, and in all other categories of debt they are attempting to stay ahead of (what are inevitable) defaults there too by adding to credit card exposure!

Further:

Total U.S. domestic nonfinancial debt increased at a 7.2% annual rate, boosted by a postwar record 39.2% increase in debt taken on by the federal government.

Right. The government is accelerating the train - and the mountain is clearly visible and getting closer at an increasing rate of speed.

What a load of crap.

PS: Most of this "new debt" being taken in an insane attempt to prevent the contraction in GDP that must occur will default as well. Have a look at the earlier Ticker from today; the math is what it is, whether people want it to be that way or not.

We have taken a 10% GDP drop in 2000 and turned it into a 20% one in August of 2007. Now, with the actions of the last year and change (especially the last six months) we've turned that into a thirty percent GDP correction that must occur (that is, an increase of 50% in SIX MONTHS!) and if we don't stop this crap it will nearly double again by next June.

You heard it here first.

Congress: Anna Schwartz Says You're Wrong

nospam@example.com (Karl Denninger) — Sat, 18 Oct 2008 15:12:58 -0400

Nearly a year ago, on October 30th, 2007, I first began petitioning Congress with the following message (among others):

"Congress MUST NOT bail out – under any circumstances – mortgage companies and investors who voluntarily entered into risky mortgage and derivative contracts during these last several years due to lax lending standards, poor due diligence or as a matter of business policy. Failure must be allowed irrespective of the damage done to these firms, because only financial failure serves as an effective check and balance against excessively risky behavior and greed. The practice of intentionally making problems “really big” in the smug knowledge that you can take ill-gotten profits and lay off the risk on society has led to a series of economic disasters that have been “charged off” on the American Taxpayer, going back to the S&L Crisis.

Congress must act to ban all off-balance-sheet “conduits”, SIVs and similar schemes, and require that any and all liabilities be properly and completely reported both to regulators and shareholders. These vehicles create an intentionally-false view of firms’ financial condition. In effect, these vehicles serve to fraudulently manipulate a bank’s balance sheet by hiding debt. These are the same accounting tricks that were instrumental in Enron’s bankruptcy. Now, on the front page of the Wall Street Journal (October 13th) we learn that Secretary Paulson is actively involved in attempting to expand this deception! "

Since then we have seen multiple petitions, all of which are chronicled at SupportedTheBailout.Org, and all of which have been largely ignored.

It is willful ignorance of these petitions that leads us to being where we are in this economic crisis.

It is willful ignorance of the facts that has caused your 401k and IRA balances to decline by nearly forty percent, lending to constrict the point that we are threatened with another Depression, and unemployment to skyrocket.

Ben Bernanke claims to be a student of The Depression and has written a thesis paper on it - one that I have read, and, in my opinion, have found to be indefensible. Of course when your defense is heard by a bunch of monetarists who believe that "the answer to all crunches in liquidity is more liquidity", you pass. Such is the ivory tower world, which unfortunately is rather disconnected from the world that those who must "do" in order to survive (instead of "teach") live in.

But Anna Schwartz is no ordinary economist. Nor is she an ordinary student of The Depression.

She, at 92, is one of the few people who actually lived through it and remembers what it was like, never mind quite possibly knowing more about monetary history, theory and the actual practice of banking than anyone alive.

She is co-author (along with Milton Friedman) of the 888-page tome "Monetary History", a book that Ben Bernanke himself has said is "the leading and most persuasive explanation of the worst economic disaster in American History."

And today, in The Wall Street Journal, she calls a spade..... a spade.

Let's use her words, of course, attributed:

"We now hear almost every day that banks will not lend to each other, or will do so only at punitive interest rates. Credit spreads -- the difference between what it costs the government to borrow and what private-sector borrowers must pay -- are at historic highs.
This is not due to a lack of money available to lend, Ms. Schwartz says, but to a lack of faith in the ability of borrowers to repay their debts. "The Fed," she argues, "has gone about as if the problem is a shortage of liquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that the balance sheets of financial firms are credible."
So even though the Fed has flooded the credit markets with cash, spreads haven't budged because banks don't know who is still solvent and who is not. This uncertainty, says Ms. Schwartz, is "the basic problem in the credit market. Lending freezes up when lenders are uncertain that would-be borrowers have the resources to repay them. So to assume that the whole problem is inadequate liquidity bypasses the real issue."

Of course it does. That bypass is intentional Ms. Schwartz. It is an outrageous and in fact insane attempt to protect those who have made bad bets from the proper outcome of those wagers.

That protection stems from the fact that both of the main protagonists in "addressing the issue", Chairman Bernanke and Secretary Paulson, in fact were prime architects in causing the problem in the first place.

Chairman Bernanke was on The Federal Reserve Board during the Greenspan years, when Alan Greenspan "pumped liquidity" after 9/11 and the Tech Wreck, yet at the same time removed essentially all regulation and oversight from the banking sector. He is thus complicit in the generation of the credit bubble that led to this disaster, and to take strong action against the perpetrators of same he would both have to admit that he in fact was one of the prime causative factors in the mess and would be forced to resign in disgrace.

Secretary Paulson is in an even worse situation - he, as Chairman of Goldman Sachs, testified in Congress as far back as the year 2000 that Investment Banks should have the shackles of leverage restraint removed from them. He failed to get that from Arthur Levitt in 2000 (President Clinton's chair of the SEC) but came back to the well in 2004 under President Bush and was successful. Two years later, having used that expansion of leverage to garner a personal fortune of $500 million dollars, he cashed out tax-free to take his seat as Treasury Secretary.

Every one of the large firms that has failed - all five (Fannie, Freddie, AIG, Lehman and Bear Stearns) - would still be in operation today if their leverage had been held at the pre-2004 12:1 limit. Therefore, Secretary Paulson must accept personal responsibility for the decisions that led to the failure of these firms, as he was one of the primary individuals in American Business who argued for removal of these constraints.

As for Anna's view on what should be done now, I again quote the esteemed (and unimpeachable) expert:

"Rather, "firms that made wrong decisions should fail," she says bluntly. "You shouldn't rescue them. And once that's established as a principle, I think the market recognizes that it makes sense. Everything works much better when wrong decisions are punished and good decisions make you rich." The trouble is, "that's not the way the world has been going in recent years."
Instead, we've been hearing for most of the past year about "systemic risk" -- the notion that allowing one firm to fail will cause a cascade that will take down otherwise healthy companies in its wake.
Ms. Schwartz doesn't buy it. "It's very easy when you're a market participant," she notes with a smile, "to claim that you shouldn't shut down a firm that's in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that's their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn't have to save them, just as it didn't save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what's been going on."

Exactly. Thank you Ms. Schwartz for adding the imprimatur of an unimpeachable expert, perhaps the most credible expert on monetary and banking policy alive, to the view that I and a few others have been shouting to Congress and others over the last year.

And the root cause?

"How did we get into this mess in the first place? As in the 1920s, the current "disturbance" started with a "mania." But manias always have a cause. "If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.
"The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it's so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses.""

Uh, yeah.

And now Congress has turned to those who were responsible for creation of the mess and believes that their tonic for cleaning it up will be effective.

The simple fact of the matter is that Congress has made a critical error in allowing Ben Bernanke and Hank Paulson to oversee this mess and its resolution. Both men are hopelessly compromised in that taking true, effective action would require both to admit to their complicity in the creation of the bubble in the first place, and in Secretary Paulson's case it would involve the admission that his personal fortune was gained through the unwise and imprudent advocacy of the very policies that led to the collapse now upon us.

Neither of these men are going to admit any such thing, for doing so would likely lead to immediate removal from office at best. Indeed, now that they have undertaken the extreme measures that have been practiced to cover up the original event and its causes, protecting those who were complicit, they might even come under federal indictment for racketeering should they come clean and tell the truth.

It is, however, the job of Congress to put a stop to such outrages before these two men, in cohorts with their friends in the banking system, lead us straight into The Greater Depression.

Indeed, history has shown that when The Executive oversteps its boundaries, or when other elements of the government do so, that Congress is the body retaining not only the authority but the requirement to act in a fashion that protects the body politic.

In this case, that protection is urgently needed, as in "today". Secretary Paulson and Ben Bernanke's pursuit of policies that are harmful has now gone on for more than a year, and should this be allowed to continue, irrespective of who holds the title in the office, we will see the destruction of financial firms and American Sovereignty piece-by-piece until what remains is unable to be saved at all.

I close with a final quote from The Wall Street Journal interview:

"Fed Chairman Ben Bernanke, of all people, should understand this, Ms. Schwartz says. In 2002, Mr. Bernanke, then a Federal Reserve Board governor, said in a speech in honor of Mr. Friedman's 90th birthday, "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.""

Ben Bernanke (and Secretary Paulson) not only will do it again, he has done it again - unless Congress acts here and now to stop him.

The Genesis Plan is one such way to stop him.

The Fraudacity Of American Finance

nospam@example.com (Karl Denninger) — Fri, 17 Oct 2008 15:13:00 -0400

I just had to coin a new word.

Audacity + Fraud = Fraudacity.

John Mack yesterday in a CNBC interview said that the capital deployed by Treasury into the banks was going to rebuild their capital ratios - not be lent out. In other words, they intend to hoard it.

This means, bluntly, that not one nickel of benefit will be seen by Main Street, despite claims by Paulson, Bush and others that this bailout is necessary for "Main Street, not Wall Street."

Liars.

Never mind that Bloomberg is reporting that the so-called "executive compensation limits" that Paulson is touting mean little or nothing:

"Oct. 15 (Bloomberg) -- Goldman Sachs Group Inc.'s Lloyd Blankfein, whose $70.3 million paycheck made him Wall Street's most highly compensated chief executive officer last year, could still earn tens of millions annually under the bank-rescue plan run by his former boss, Treasury Secretary Henry Paulson."

Very nice. So the taxpayers hand out billions and the executives still rake it in.

Where is the accountability?

CNBC's Fast Money finally started talking about the outright fraud and lies last night. Dylan Ratigan was absolutely on fire about the fact that Paulson was in fact one of the executives lobbying hard for removal of leverage limits in 2004, just two years before he took the position at Treasury (and cashed out $500 million in Goldman Sachs stock tax free.)

I and a few others have been peppering the media with this, and finally, someone woke up to the fact that the very same people who made this mess now want we the taxpayers to pay for cleaning it up - after they ran off with all your money!

Never mind that its unlikely to work.

Nor does it stop there. AIG continues to draw on their "credit line" with The Fed. Inquiring minds want to know a few things here, chief among them being why suddenly is there $80 billion of hard money required in a business that is "fundamentally sound" in excess of cash flow, and where that requirement did not previously exist.

I'm suspicious as hell on this one guys, and my suspicion generally points in the direction of Lehman's Credit-Default Swaps.

The claim by the DTCC and ISDA is that the total "actual exposure" is somewhere in the area of $6-8 billion once all the contracts have netted out.

Let's examine this, because it leads to only two possibilities, both of which are extremely uncomfortable.

First, if the claims are correct: Then the entire CDS game is one gigantic high-finance version of "pick pocket."

That is, you come to me for a CDS on Lehman. I charge you $100,000. Then I immediately go find someone who will sell me the same contract for $90,000. I have now "picked your pocket" to the tune of $10,000, and (theoretically anyway) I have no risk. This continues until the last sucker says "no mas!" on a cheaper price, at which point that particular chain of CDS come to a close, until the next buyer shows up.

If this is the essence of the CDS game then the entire scheme and the dealers' insistence on keeping these things off a public exchange is an artifice with intent to defraud. Why? Because by keeping bid/ask and O/I hidden these banks are able to continue to play this game of "steal from the guy you sell to by obscuring the price"; indeed, that is the essence of the trade! This market doesn't exist to make a market or to set a price for risk, it instead serves as nothing other than a high-finance looting operation with everyone putting in the maximum effort to obscure market facts so as to be able to maximally exploit the customer!

Why do I make this charge? Because there were allegedly $600 billion worth of contracts written on Lehman. If only 1% of that turns into real money needing to be paid out, and recovery on the bonds was literally under 10 cents, then the actual "notional at risk" was $540 billion. As a result we have almost none of the market being used either to insure actual bonds or to place bets on the firm's demise (or health) - essentially the entire CDS marketplace exists to do exactly one thing - steal from the buyers of this "protection"!

If I ran a place that was called a "Tavern" but 99% of the people who were there in fact came to deal cocaine, and only 1% of the people purchased drinks and food to be consumed in my "establishment" I'd be instantaneously raided and shut down by the cops, and with good reason. I would be operating a criminal enterprise - despite calling what I'm doing "serving food and adult beverages", in point of fact I was providing cover and concealment to a highly-illegal enterprise that was engaged in a prohibited activity. Ditto if my alleged "Tavern" was in fact cover for a bookmaking operation and again, 99% of my "activity" was in fact illegal sports betting while 1% was the sale of alcohol and food.

If the ISDA and DTCC claims are correct this is the fraud of the century and every bank and institution involved in it needs to come under immediate federal indictment.

The other possibility is more ominous - ISDA and DTCC are lying, and in fact there are hundreds of billions of dollars in real claims that need to be paid off next week.

The latter explanation happens to (inconveniently) fit with AIG suddenly needing $80 billion worth of actual money. See, AIG's derivatives desk is known to have written CDS on damn near anything or anyone in considerable size. It was a very profitable part of the operation while the music continued to play, but now it has imploded on them, as all overly-leveraged schemes eventually do.

If this explanation is correct then we have a whole different set of problems. In that case the obvious question is whether OTS was complicit in allowing a regulated institution's wholly-owned subsidiary with recourse to the parent to lever up to a degree that vastly exceeded any reasonable standard of prudence under banking and insurance regulations. The implication there is that we had willful and intentional refusal to enforce banking and insurance regulations on both a state and federal level, because AIG was in fact a regulated entity - this was no hedge fund!

The latter scenario also leads one to question whether the $80 billion drawn thus far is in fact going to pay off hedge funds who made bets on Lehman's collapse! If so then this is a further outrage, in that these firms bought these "swaps" from an entity that was insolvent at the outset of writing them, and the idea of the government stepping in to protect hedge funds from bets they made with a firm they knew didn't have the capital to pay is beyond outrageous, not to mention a raw fleecing of the taxpayer to cover the bets of an illegal and under capitalized casino that was enabled and powered by willfully-blind regulators!

Either way we've got a problem with the only real question being exactly who has been lying to whom, where we need to point the Federal Prosecutors, and from whom we should seek to disgorge the ill-gotten gains with Civil RICO (Racketeering) lawsuits.

There's more fraudacity to explore, but this should give the prosecutors plenty to start with.

Do you think we can find one or two somewhere in this country that aren't actually in bed with the fraudsters?