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From Bernanke's speech today....

""They have taken a lot of losses. They are also being very protective of their liquidity because they are unsure of the possibility of additional off-balance sheet assets coming onto their balance sheets and therefore they are being rather conservative in making new loans which has implications for the broader economy," Bernanke said."

There 'ya go.

What did I post this morning?

Yep.

See, the banks know the game.

They have an alleged "wrap" on all these "assets" which allows them to "claim" that their credit book is all "money good."

Same deal for places like Fannie and Freddie that have roughly $5 trillion of mortgage paper in their "credit guarantee" book, with a fair bit of it at LTVs over 80%. They claim "money good" because the mortgage insurers wrote policies (swaps, effectively) against the potential failure to recover the full loan balance.

The problem is that essentially none of these swaps are any good.

That's the bad news.

The worse news is that the situation is going to get worse over time, not better, because home prices are going to continue to fall, not rise, for at least another one to two years, and before they bottom we will see the long end of the interest rate curve start to rise too, which will put further downward pressure on prices.

The NAR (which has been all pollyannaish until recently), Fannie and Freddie are all predicting double-digit additional percentage declines, and Case-Schiller is on board with that too.

As this occurs it "uncovers" more and more exposure in the insurers (swap writers) which in turn results in more degradation of the credit book, which in turn causes the real cost of mortgage money to rise.

This in turn causes more home prices declines which........

Yeah.

Here's the thing - in "normal times" being a MI company is a license to print money, just like writing swaps is. If the "base case" is that only 1% of all prime mortgages default, and you only insure the top 20% of the note, then you only lose if the default happens before the note drops below the principal value.

In a normal market this is unusual - you might only have to pay on 1/2 of 1% of the loans you write. Same thing applies to swaps - in the recent past we had a year where there were essentially no corporate defaults!

But in this market it is anything but normal, because the default percentage rises to 2 or 3%, and you have to pay on most of them, and corporate defaults are rising too!

The underlying model that firms have used to price this risk is mathematically unsound in a declining home price marketplace.

Specifically, the model relies on the assumption that you will only experience losses on 1% or so of the loans and for the most part price appreciation will prevent you from having to pay as the foreclosure sale will recover most or all of the deficiency.

Neither of these assumptions are valid in today's market!

Here's the proof (click for a larger view):


Note that we have $142 billion worth of exposure "off prime" with 21% of it delinquent 60 days or more yet it was all rated "AAA" at origination.

Most 60+ delinquencies will foreclose. The 2nds and HELOCs are essentially total wipeouts in an environment where home prices are declining as foreclosure nets you nothing since the balance exceeds equity.

Now take a look at the real losses likely to be seen here. Assume we're talking that most of the 21% delinquent on the $142 billion goes "boom", we have $30 billion in exposure. Being nice and allowing a recovery of 50 (hopelessly optimistic) we have $15 billion in losses.

The problem is that MBI, Radian and Ambac's market cap combined is less than $4 billion.

So we have $11 billion in "forward, unrecognized and uncovered" losses but Freddie is going to raise $6 billion? Yes, I know, they have some capital cushion, but is it really wise to invade that when the problem is nowhere near over?

We also haven't accounted for losses in the prime book - at all. And how much of that "prime" is really prime and not "Fast and Sleazy" paper that was sold to them as prime but in fact is Alt-A?

See, this is at today's home prices and loss experience - but both Freddie and Fannie are predicting further home price declines, which will feed into more delinquencies.

The bottom line is that the claimed "credit guarantees" are crap and this is only Freddie, which has less exposure than Fannie (they were nice enough to publish a pretty table that made this pretty easy to put out there for 'ya.)

You can extend this problem to both the investment and commercial banks; the basic problem remains the same - the so-called "guarantees" represented by these OTC swaps and other "derivative devices" are worth nothing as the money simply is not there to make the payments.

Once the first blowup bankrupts the guarantors everyone else is immediately running uncovered.

There is no way out of this box. We have had a nearly-10-year run where all this paper was written in a mispriced environment under the premise that the music would never end.

Bernanke has admitted that he knows this in that the banks are "hunkered down" and unwilling to put more exposure out in the market because they know what is coming.

But Bernanke is compounding the error by not forcing institutions to take down their leverage.

You force them to take down leverage by demanding that they either prove their swap and "insurance" counterparties can pay against the most pessimistic assumptions in the current environment or those policies must be declared "worthless" and your assets then have to trade on their underlying credit quality.

If he was to do so then we would find out who is swimming naked (and there would be plenty of people who are) but the bleeding would stop in the banking system because once the trash paper is sold it's not your problem any more - it is now owned by whoever bought it.

Remember folks - if hedge funds want to bet on recovery of this paper and buy it for 80 cents on the dollar on alleged "money good" paper, and they're wrong, we do not get a systemic failure.

People who are risking their own capital get to either make or lose money.

But if the banks continue to hold this paper trying to get "par" for it rather than take the losses now and they are wrong we all get screwed because Bernanke has literally loaded over $400 billion dollars of this trash on The Fed's balance sheet, and to bail that out, if it becomes necessary, will require transferring that bad debt to the United States Treasury with catastrophic results.

Worse, if this blows up in our faces you'll find that you suddenly need 50% down to buy a house, because nobody in their right mind will loan on more than half of the underlying collateral value.

This happened during The Depression for this exact reason - what do you think a development like that will do to house prices?

Bernanke is gambling with our future by refusing to act to force the deleveraging to take place now through recognition that these swaps and "insurance" policies are, in aggregate, worthless.

Congress, for its part, is sitting back and fiddling instead of insisting that the truth of these firm's financial positions be recognized and the underlying credit quality be the basis upon which they trade.

It's time for you to either stand up and raise hell or shut up, because come the July Recess, which is only about a month and change away, there will be no further Congressional action of consequence until after the Inauguration in January of 2009.

We don't have that long.

Oh what a tangled web we weave, when we practice to deceive....

Freddie Mac posted their loss yesterday and as if on cue investors bid up the stock by nearly 10%.

Why? Well, look at how our government "regulates" those who refuse to be honest in their accounting:

"The company’s regulator, which only a month ago chastised Freddie Mac for questionable accounting policies, also recognized the results by reducing the size of the company’s financial safety cushion."

Yeah, there we go. Accounting doesn't matter, right?

Speaking of which, did 'ya look at their Level 3 exposure?

Institutional Risk Analytics said this:

"'Both these companies are clearly going to be insolvent by the end of the year, but everyone knows that Congress will do anything to keep them afloat, because if Fannie and Freddie go under, the entire global financial system will melt down,' said Christopher Whalen, a founder of Institutional Risk Analytics, an independent research firm. 'These companies' earnings don't matter. Their accounting hardly matters. People buy the stock because they believe the federal government will bail them both out if things get really bad.'"

"Cooked" accounting is fine and the inability to earn a profit doesn't matter, because "someone" will let us rip people off and then bail us out.

Does anyone care about the truth in American Business any more?

Oh there will be those "sacrificial lambs" offered up. Like, perhaps, Countrywide?

"Rejecting the arguments of Countrywide executives and directors that they were unaware of lax loan operations that led to ballooning defaults, Judge Mariana R. Pfaelzer of Federal District Court in Los Angeles ruled Tuesday that she found confidential witness accounts in the shareholder complaint to be credible and that they suggested ' widespread company culture that encouraged employees to push mortgages through without regard to underwriting standards.'"

No, really? The bankers would never lie, cheat and steal?

Will we ever see answers to exactly who wanted to buy PUTs on Bear Stearns 50% out of the money and requested the option market markers to open up those PUTs for speculation? Do you think we will ever see Congress subpoena those market makers and the OCC to get the names of people who made the requests, then stick them under oath and travel back up the chain until we get to the people who started this?

There is a long history of looting operations conducted by people with power and money.

In fact, there is plenty of evidence that The Federal Reserve was initially formed as part of such a looting operation conducted by bankers against certain institutions in the United States.

That was neither the first or last time such operations have been conducted.

Look at the history of the British banking system and its sovereign debt for yet another example.

Of course back then there weren't computers, email, and logs, and the usual practice was to simply kill the person who you "planted" the rumor with after they initiated it so they couldn't testify in a court as to where it all came from.

These days records have a nasty way of showing up at the most inopportune time, because we have gone from writing things down on paper to recording them in a computer and sending them around, and the latter often results in lots of copies being made that the originator isn't aware of.

The discussion on "monetary system changes" continues to get lots of play at the forum.

Unfortunately the "I saw a witch, get the sticks, rope and kerosene!" reaction also continues, instead of focusing on where the real problems are.

This is why I wrote "How Freedom Dies"; it is very easy for people to focus at an area that does not really bear on the issue at hand and try to destroy it, because it's the "most visible" means of retribution.

In doing so they give the fraudsters the very means to destroy them instead and history shows that every time you open up your kimono and give people with power and money a free shot they take it, much to your chagrin down the road.

The solution to this entire mess is the same that it was (but not taken) back when the Bank of England was essentially looted, and when our banking system was looted in the early 1900s - find the market participants who have engaged in fraud via various forms, whether they be mortgage bankers handing out liar loans and misrepresenting them as "AAA Prime" paper or whether they be people in the marketplace who initiated the plethora of (false) rumors over the last many years about various companies, irrespective of whether the intent was to drive prices up or down, and prosecute them.

We have existing laws that make that conduct illegal. Investigate the activity, charge the wrongdoers, prosecute them, get your convictions and toss the lot of 'em in prison with a bunch of 7' tall rapists in the exercise yard, no guards, and a $100 video camera in the guard shack.

Then post the "results" on YouTube as a warning to the world - try that again in this country and this is the consequence you will receive.

That will be the last time it happens.

But until we take that sort of step and hold people to account, this sort of "looting operation" will continue, and we the people will continue to get screwed.

As for the "CDS Mess", I have a solution for that, but it requires that you understand how these things work.

Let's say that you buy a CDS (Credit Default Swap) from me. You pay me $10,000 for "protection" against Company X defaulting. Let's say that if Company X does default, I would have to pay you $100,000.

These trade based on the risk of that default from day to day.

Ok, now I, the guy who wrote that swap, go bust and can't pay, and by the way, Company X does default.

How much do you lose?

If you say "$100,000!" you're wrong.

You lose $10,000 - the amount that you paid for the swap.

Your opportunity cost is $100,000 (profit you should have gotten but didn't) but your actual monetary loss is $10,000.

Ok, so why are these things such a big deal?

They are a big deal because "you" (the guy who bought the swap) have been "marking" your portfolio of bonds and other investments based on the claim that I can pay!

This is a lie, because "you" are well aware that I can't fork up the coin. I simply don't have it; the mathematics in this regard are simple.

You are committing fraud and claiming that you have a "good asset" because of this "wrap", when in fact you are well aware that the wrap is worth nothing.

This is the basis of the claims that "we couldn't allow Bear Stearns to fail."

The entire claim and chain of events rests on the fact that market participants, up to and including Ben Bernanke at The Federal Reserve, were and are aware that these CDS contracts are in fact fraudulent in that there is no way performance can take place, yet everyone up and down the line is allowing these "assets" to be counted as "money good" on the books of banks and other financial institutions!

THIS is the key item in the debate folks.

The rest of this noise making is mental masturbation and intentional misdirection intended to keep you from asking the tough questions and demanding that existing law be enforced.

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

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

While any one company could claim that its insurance is "money good" that's not the point.

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

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

This is out and out fraud and must be stopped.

We the people are being systematically looted by these people and our prosecutorial apparatus sits on its butt and sips Starbucks Lattes instead of doing their job!

It is time for we the people to say ENOUGH.

Call Congress and demand that they stop this charade here and now. Every firm that has claimed their paper is "protected" by these wraps must be forced to identify the counterparty that currently holds the risk and those parties must be forced to prove that they can pay any and all claims against those policies.

If they can't (and the default case must be "they can't", since that was in fact Bernanke's and Geithner's position under oath!) then those wraps must be considered "doubtful" and reserves must be taken against the underlying credit quality.

Do this and we immediately identify who is broke and who is not, the market finds its proper price for these assets, and as a consequence the market will clear.

Everyone wants to make this whole mess complicated.

Its not.

It is in fact very simple.

The only "complication" is that there are thousands of people who are ripping the American People off wholesale, waving their arms around in the hope that you'll let them get away with it.

Don't fall for it.