The Market Ticker

America, and Americans face a stark decision - and a choice that must be made now.

Not next month at the polls, not next week.

Today.

I have been writing on this subject, petitioning Congress, and both calling and faxing Congress - and you - for the last year and a half.

We now sit literally days away, with a high probability, of a credit market "dislocation" that will change American finance and decimate the stock market. 

That is, worse - far worse - than what has happened thus far.

Try on for size 2-3,000 points down on the Dow from here.  25% more than has been lost thus far, more-or-less "all at once."  The probability of this event is now in excess of 70% - within the next few days to two weeks.

The Politicians know this. 

They were promised that the market would not blow up if they passed Paulson's and Bernanke's bill. 

They were lied to, and the first "blowup" happened.

You, the people, were promised that passing this "stabilization" bill was the right thing to do too.

You were lied to.

Now we are sitting on the edge of the second blowup - "The Big One."

Among other things, today we learned that The Fed has lost control of the Effective Fed Funds Rate - their own overnight lending rate.  They were forced to change their interest rate on reserves in order to try to get it back under control - and there is no reason to believe their efforts will be effective.

The truth is that our nation, and indeed the world, has too much debt for its ability to earn income and has had since 1968.  As this became apparent to the people at The Federal Reserve and Treasury, in the 1980s starting with Alan Greenspan, interest rates were artificially kept low for a long period of time to encourage you and others to go into that debt - debt you and these firms cannot possibly repay.

This is why we had the crash in 1987, why LTCM blew up in the 1990s, why we had an Internet Bubble and now why we had a Housing Bubble.

All of these bubbles were intentionally created by The Fed, Treasury and Wall Street Banks to keep the charade alive that you could take on more and more debt and they could make more and more money.

We are now out of bubbles and ability to support bubbles, and America (and the world, in fact) is out of the ability to support more debt. 

We are now borrowing money to cover up the fact that millions of Americans and tens of thousands of companies are bankrupt, and the banks and other institutions that loaned them money are likewise bankrupt, as the people who owe them that money can't and never will be able to pay.

The people who in turn loan America the money it needs to operate - over $2 billion a day - have become aware of this fact.

This is very bad, because nobody will loan money to someone forever when they have no reasonable belief that they will ever be paid back.

There are only two options remaining for America, and we as Americans, and our politicians, must choose one of these two paths.

Neither path is easy.

Neither path is pain-free.

The path that will lead us to where we can prosper involves a great deal of short-term pain.  It involves forcing all of the bad debt - perhaps your mortgage, the bad corporate debt, the "Ponzi-Scheme" style debt that has been layered up one on top of another - out into the open and forcing it to default.

On purpose.

This means that if you are underwater on your home, you will lose it and your credit will be destroyed for a few years.  It means you may have to file for bankruptcy.  It means a great deal of short term pain if you are in this position.  It means that companies that have taken on too much debt will be forced to either pay down what they can, or go bankrupt if they cannot.

This path will result in higher unemployment for a time, it will result in lower standards of living. You will not be able to spend money you do not have, and neither will our government.  Both the government and we the people will be forced to live within our means.

The second path is for Ben Bernanke, Henry Paulson our government and you to attempt to do what we have been doing. 

That is, to borrow more money to pay the interest on money we have already borrowed.  To refuse to accept that those who borrowed too much, and who can't pay, must declare that fact and face the potential bankruptcy that comes from being too far in debt and unable to make good on obligations.

This is now a critical matter for our nation, because our nation's political leaders have chosen to take the private debt of companies and individuals and attempt to guarantee it with the credit of the United States. 

However, The United States is just as broke as we are individually - in fact, more so. 

Treasury will have to issue three trillion dollars of new debt over the next 12 months in an attempt to make this work.  But Treasury has been using very short-term debt - mostly four week and 13 week "bills", to fund the existing debt, because they are cheaper.  As such the total amount of these auctions could easily reach five trillion dollars over the next 12 months.

Already, Treasury is issuing more than $100 billion dollars in this debt a week, on average, including new issues and rollovers.  This is about double the total amount of debt that foreigners (or US interests) hold in total, and we have barely begun to actually issue the debt necessary to make the "TARP" operate.

We are, in effect, borrowing to pay interest.  If you have ever tried to do this personally, you know that doing so almost always leads to bankruptcy.

It will for us as a nation if we don't stop it now.

Our choice as citizens is to either accept that those of us who have taken on too much debt will and must go bankrupt, declaring our insolvency and settling what we can, whether we are an individual, a corporation, or even our nation, or whether we will continue to attempt the charade of printing up more and more debt (or money) in an attempt to cover it up.

We are very close to the point where more debt causes the GDP - that is, the totality of our nation's output - to contract instead of expand. 

At the point that line is crossed, our nation's monetary and economic system will fail with disastrous consequences.

This is, effectively, what happened in Iceland, and it came almost without warning.  The price of everything they import tripled overnight.

We as a nation must choose, and we must do it now.

Nobody wants to accept that they cannot have a new car if they can't put down 10 to 20% of the purchase price, and that they can't "roll over" the old balance into the new loan, but that doesn't make it not true.  It is, in fact, true.

Nobody wants to accept that they really need to put 20% down on a house and that houses can't sell for more than 3x incomes, on average, but it is in fact true.

Nobody wants to accept that having college cost $200,000 for four years is obscene and that allowing our kids to graduate with that sort of debt is outrageous, but it is in fact true.

Your 401k has already been turned into a 201k because our government has decided to lie about the fact that dozens if not hundreds of banks and tens of thousands of businesses, not to mention millions of individual Americans, maybe even you, are in fact broke.

Not everyone, however, is broke - but everyone's 401k, 403b and IRA is being decimated, and if we do not act now, we will all - the broke and the prudent - suffer the consequences of trying to lie about the financial state of our nation's banking system, our nation's companies and our nation's families.

We may be days away from an international credit incident originating outside of the United States.  Foreign nations, banks, and businesses have "levered up", or taken more risk, than we have.  They too have chosen to lie.

As money has flowed from "not guaranteed and possibly lying" firms' debt to that which is guaranteed by the government, the government has seen necessary to guarantee more and more liars, lest further firms and types of debt fail.  As each type of debt becomes guaranteed it "sucks the money" from the non-guaranteed, and within weeks or days The Fed is obligated to guarantee yet another type of debt, lest it collapse too.  We now have general corporate debt blowing out to wide levels, which will soon shut off all new corporate borrowing - even for sound companies - because there is no reason to buy their debt when you can buy guaranteed debt of some other type.

The Federal Reserve, starting with the "TAF", now has an entire alphabet soup of "facilities" to guarantee various debts, and the FDIC has increased its coverage.  In recent weeks The Fed's facilities have even been extended overseas via "swap lines" and various other charades - it is no longer just United States interests being backstopped, it now includes foreign banks as well.

All of this is for one purpose - to cover the fact that many of these businesses are broke - that is, to cover up the lying.

But as each lie is covered up, the market calls the bluff and forces yet another coverup.  The Fed is now creating new facilities to the tune of hundreds of billions of dollars they do not have, effectively displacing private lending on a global scale, now operating with leverage of more than 40:1 - all so the lies do not have to be admitted to.

But with each new charade the spiral tightens at an increasing rate.

At some point the people who have lent all of these firms money will cease to be willing to do so because all debt will become equivalent to US Debt, and all of it will be considered "dangerous."

The people who loan us money - the oil producers, the Japanese and the Chinese - are able to do the same math I am. 

They know the same facts I know, and you should know.

They know the same facts that Henry Paulson and Ben Bernanke know, but have not shared in an open and honest fashion with The American People - or with Congress.

We are on the cusp of this dislocation - and this realization - being forced upon us.

I believe Treasury has been attempting to "kick the can down the road" as is the usual pattern in Washington DC.

Unfortunately the can has filled up with cement and there is now a very high probability that instead of the can being able to be kicked down the road until next year after the elections the second-level dislocation - the "big one" - is going to happen within days. 

It is my opinion that we must, at all costs, protect the borrowing ability of our government - the Treasury of The United States.

We must not use our government to protect the liars in American business, no matter whether they are banks, automakers, the local store owner or ordinary Americans.

If we are to get through the difficult economic times we are in and which lie ahead, we must guarantee that our government is able to borrow money at a competitive rate. 

We must make sure that the government is not lumped in with the liars, lest the government's ability to borrow get cut off or become prohibitively expensive.

This decision to differentiate the government from the liars must be made now.

Our leaders must stand up and demand that Ben Bernanke and Hank Paulson stop backstopping the bankrupt.

We must withdraw the TARP and not allow $70 billion dollars of borrowed money to go to pay bonuses at major Wall Street banks - $70 billion dollars we do not have.

We must not allow this money to be used to run mergers and other corporate "raids."

We must stop Ben Bernanke from expanding his "alphabet soup" of lending facilities, and force those who are in fact bankrupt into the open, where the free market's solution - bankruptcy - awaits.

We must force home prices down so that you can truly afford to buy a house, not keep prices artificially high so that the banks and other lenders don't lose money.

We must recognize and admit that the debt merchants - the banks - are opposed to doing the right thing not because their opposition is good for America and it is to everyone's benefit that they be protected, but because by forcing hidden defaults into the open some of them will go broke, and all of them will, in the future, have far less business to compete for.

Once the bad debt has been forced from the system then and only then should Congress step in, if necessary, and charter new banks.  Spin them off to the public in IPOs with the money was going to be used for the TARP - but only after we have restored the ability of America to use credit once again by defaulting the bad debt that currently exists.

If we do not make this choice, and make it now, those who have the money we are borrowing - the Chinese, the Saudis, The Japanese and others - will make this decision for us.

They will come to the conclusion that they will never be paid back.

At this point our way of life will be irretrievably altered.

Your 401k, which is now a 201k, will become a 101k or even a 51k.  The DOW could fall to below 5,000 and the S&P 500 to 500 or less, with 20 years or more of gains wiped out.

You have already seen nearly half of your money disappear. 

You could see another half disappear - within days.

That is a 75% loss from October 2007 values, and before you scoff at it, look at a chart of the Nasdaq from 2000 to 2003.  Our entire stock market and economy have become just as farcical as the Nasdaq was from 1995-1999.  I ran a company in the Internet space in the 1990s - I saw it all, and most of the firms that failed during the Tech Wreck were more honest than the banks and mortgage lenders during the housing bubble and to this day!

The day for we, as Americans, to make this decision has arrived. 

We must do so today, not after the election and not in January.

We must tell Congress now that it is critical for them to protect America's credit as a nation, not the credit of banks, business who have done imprudent things, and even ordinary Americans who have done imprudent things, whether those imprudent things were done intentionally or not.

We must make clear that we understand this will not be an easy decision, or a painless one - but it is a necessary decision, it is our decision, and it is the decision we demand they enforce as our elected representatives.

Congress must "grow a pair" and stand up for Americans, here and now, today, telling the world that these liquidity facilities will not be permitted to continue, that banks and other firms who have concealed the true state of their finances will be closed and their executives jailed if they do not immediately confess, and that house price "supports" will and must be withdrawn, including the provision of "low down payment" and "high debt-to-income" loan options.

Congress must direct Ben Bernanke to either withdraw his "alphabet soup" or Congress must revoke The Fed's charter and replace The Fed with a monetary authority that will tell the truth and act with full transparency.

Treasury must be directed to cease implementation of the TARP and return all funds not yet spent to the general fund.  The short-term cash management debt that Treasury has issued must be allowed to run down and not be rolled over so that the radical expansion of issue in the Treasury market ceases and in fact is reversed.

We must choose America. 

You have seen, today, another five percent decline in the stock market, despite the claims that "credit is improving."

That claim is a lie. 

Credit is not improving - it is being replaced by The Fed being the only issuer and guarantor of credit - an impossible situation that is ruinous to our nation and its prospects.

We face an imminent collapse of both stock and credit markets if we do not act, and act today.

To Congress: Is there not one statesman or woman who will stand for America and her people, not for the bankers and fraudsters on Wall Street who have given you millions in campaign contributions?

To The People: You were promised a solution, and you didn't get it.  Are you going to sit on your hands while our nation's economy implodes?

Those are your choices, and you must make them today.

Choose wisely.

(I hope I'm wrong, but fear I'm not.....)

You only think the Stock Market has been smashed.

Just wait until you see what will come next.

If you're playing "Buffett", following his claim (note: there is no penalty for lying on national television about what you're doing in your personal account) that he's buying here, there is a little ugly fact you need to be aware of.

That fact is treasury issuance.

See, to fund all this crap that Congress, Paulson and Bernanke have in the pipe (you know, the TARP, the newly-minted SIV that Ben announced this morning to buy commercial paper, etc) the treasury issue requirements will be north of three trillion dollars in this fiscal year.

Oh, and that's before Obama wins (and he will) and promises another $1 trillion worth of new spending without a nickel's worth of ability to fund it.

To put this in perspective the total amount of treasury securities owned by all foreigners at present is about $2.7 trillion.

Only a few months into this we're already requiring a crazy "tail", which is the amount of "goose" that has to be paid in order to get people to take down that debt.  Its running around 20 basis points right now, and there was one disastrous auction that ran 40.

Historical norms are in the ~2-3 basis point area for off-the-run securities.

Now why does all this esoterica matter, you ask?

You've probably heard that the "IRX", or 13 week T-Bill, has come up in yield recently, and this is being touted as a clear sign that the credit markets are normalizing.

Not quite.  Price and yield move in opposite directions, and when you issue a lot of short-term supply, the price goes down (supply and demand, natch), while yield goes up.

In fact, kinda like "straight up."  Impressive eh?

But what's nasty here is that right now we're seeing a flight INTO longer-term bonds (the 10 in particular), which means the market is anticipating another stock panic, and with good reason.

See, Treasury has only two options here:

1. If they issue all in the short end of the curve (as they're doing now) they flatten the banks, as the entire point of a bank is to borrow in the short-term market and lend in the long term.  When you compress the yield curve you destroy their capacity to make money off their ordinary business model.
2. If they issue in the long end of the curve (e.g. 10s and 30s) then the long end will skyrocket in yield.  Anyone remember 18% mortgages?  They could reappear.  This, of course, will destroy what's left of the housing and consumer credit markets.

Now sure, The Fed can start printing money like mad and buy all these Ts, making their balance sheet expand like a balloon - or a bubble.  And Bernanke, yesterday in his testimony, claimed that this didn't constitute "printing money" or "inflating the money supply."

He may be technically correct but in practice he's lying through his teeth, and unfortunately Congress is both too uninformed to call him on it and lacks the balls to stop him (which they can do through the threat of, if not actual, legislation.)

His production of money in exchange for Treasuries is nothing more than a sham sterilization action.  He thinks this will go unnoticed by the markets, because he's swapping a dollar for an "illiquid" asset.

The problem is that this is only monetarily neutral if the asset is actually worth a dollar.  If it is in fact worth 50 cents then he printed the other 50 cents, and devalued every other dollar in the world by the same amount.

The claim, of course, is that these assets are in fact "money good" but illiquid. 

I call bullshit on that claim.

An asset is worth only what an uncoerced buyer and seller will transact at.  This is first-semester economics, and Bernanke, who claims a PhD, is fully aware of that fact.

So he, like Treasury with their TARP, is effectively buying assets that are not worth what their face value indicates.  In this case Bernanke gets around the inconvenient law that prohibits him from purchasing things (as opposed to "discounting a note", that is, lending) by setting up "private" SIVs run by JP Morgan/Chase (gee, Jamie Dimon, no conflict of interest there!) and then lending the funds to the SIV.

But wait - wasn't this Paulson's original SIV plan back in 2007? 

It sure as hell was. 

It went exactly nowhere because the banks came to the conclusion that they were being robbed; there was in fact no value equal to the claimed face in the instruments, and that plan died on the vine as a consequence.

Now, suddenly, it reappears for ABCP (asset backed commercial paper) to "liquefy" the commercial paper and money markets.

Horsecrap.

Bernanke is doing what Paulson tried and failed at in the "free" (coerced by arm-twisting by Paulson) market through executive fiat, and he is printing money to fund it.  Exactly how much money he is printing (as opposed to lending) depends on the precise amount of overpayment that is being induced through these so-called "loans", but that it is happening is not open to question. 

Why has this become necessary? 

Ben and Hank produced a dislocation in this section of the marketplace by favoring other debt instruments with federal guarantees, thereby forcing money out of these instruments. 

This in turn created major problems for money market funds who buy this paper as a routine matter of course in that when they needed to redeem deposits they suddenly found no buyers for the securities, as those people had fled to other instruments that Ben had guaranteed payment on!

As each new facility is rolled out by Ben and Hank a new area of debt becomes backstopped by the government in some fashion, thereby forcing money out of other instruments and causing those instruments to become distressed! 

We are rapidly reaching the point where only The Fed and Treasury are providing any lending at all!

This is insanely dangerous to economic and monetary stability; all market discipline has been removed and now we're seeing in the credit markets that which began in the equity markets with Bear Stearns.

Ben and Hank are going to produce the bond market dislocation that I have been warning about since earlier this year if he is not stopped immediately.

The base gambit is cute - force all this new Treasury issue out into the market before the election and Inauguration, when Hank is going to be replaced with someone who might not be nearly as charitable as Hank is to issuing Treasuries like a drunken sailor, and pray that the bond market tolerates his game long enough for the issue he needs to fund this abortion to clear into the marketplace.

The ugly is that there was a small inversion in LIBOR a week or so ago.  That's really bad, as LIBOR normally never inverts.  As Ben has played his games of late the inversion disappeared from LIBOR but moved over into the intermediate area of the US Treasury Curve, where it is far more dangerous.

China, Japan and Saudi Arabia should bring the curtain down on this farce right damn now, because Treasuries are rapidly becoming no more secure than ordinary corporate debt and the buyers sure as hell aren't being compensated for that risk.

Treasury buyers are being robbed blind along with US investors who think they're "fleeing to safety."

Nonsense; as I showed yesterday the problem is that additional debt issue no longer renders much (if any) of a positive return on GDP - no matter who issues the debt - public or private. 

The ugly little secret in that graph, if you study it a bit more, is what happens when interest rates spike higher.  Go back and look specifically at the period surrounding 1980, when we had sky-high inflation.  Notice that we didn't get back to trendline until bond rates came down - way down - as we started having supply absorbed by Japan, China and Saudi Arabia in the 1990s and into this decade.

There is a very real risk that this Treasury Issue could force GDP return on new debt below zero.  If that happens then the stability of the monetary system disappears immediately and you will see instantaneous and very large fails in the Treasury marketplace.

The consequence of this event would be catastrophic.  Ben would have only two choices - print raw money, which would immediately collapse the Treasury marketplace, or get Treasury and Congress to immediately reduce issue and spending to sustainable levels.

What would "sustainable levels" be?  Given that issue is running $3 trillion year-on-year, this could result in an immediate and forced cut in all federal spending by fifty percent or more as the TARP and other program money will have been spent and cannot be recalled.

Yes, you read that right.  Now go look at the Federal Budget and you will find that you could eliminate all discretionary programs and all of the military and not get there.   This means that in order to attain stability we would have to immediately gut Medicare and Social Security by about 50%, cut our military budget dramatically, perhaps by 25% or more, and eliminate essentially all discretionary spending - all farm subsidies, the Department of Education, Unemployment Assistance and more.

Oh, and having done that, the long end of the curve would probably still spike to 10%, which means 13-14% mortgage rates.  Cut the value of every house in America in half - again - from here.

The equity markets sense this.  Not one equity trader in 1,000 understands it, but they all intuitively get that something is very wrong with what has been done recently, and that what's coming is going to be very bad - perhaps ruinously bad, especially in the corporate sector where corporate debt issue is a necessity to fund operations, and not just in the short-term commercial paper markets.

Running on free cash flow alone, most corporations would make 20% of what they make today - if that much. This, of course, collapses the "E" side of the balance sheet, which means that the "P" in P/E has to come down.

Way down.

Oh, and that assumes they can take down the debt without imploding, and many of these firms will not be able to do so.

If you were wondering where I got my S&P 500 target of 500 - or perhaps worse - this is part of the computation.  Its not all of it by any means, but it certainly is part of it.

There is exactly one way to stop this idiocy, and that is for the bad debt that exists out there to be forced into default and thus cleared from the system.  This will cause the debt to GDP level to come down.  Clearing it back to the point where a 1:1 ratio or better exists between GDP and a dollar of debt may not be possible or reasonable, but if we don't stabilize this situation - and soon - we are running the risk of literally crossing the event horizon.

Congress must act now.  The fuse is about to go inside the box and once it does, you can't snip it any more.  It may, in fact, already done so.

Specifically, Congress must:

1. Force the immediate cessation and unwind of these "special facilities", including the so-called "money market" liquidity facilities.  While its bad if money market funds break the buck and return only 98 cents, the fact remains that every one of these funds has a statement in the front of the prospectus that says "may lose value."  If The Fed refuses to stop coddling its member banks and tampering with the credit markets then Congress must force this outcome via emergency legislation.  We must stop forcing money in the debt markets out of various portions of the market and into the "guaranteed" ones by removing the guarantees, or we will wind up guaranteeing all of it - an impossible task, as there is some $53 trillion of private credit in the marketplace and we don't have the money!   Bernanke is a trapped rat and his desperate actions are now threatening the sovereign debt of The United States.
2. Force a full stop on the insane pace of Treasury Issue.  We cannot allow a bond market dislocation.  If one occurs we will suffer an economic depression.  Not might - WILL.
3. Repeal the EESA and force Fannie and Freddie's portfolios to unwind, effectively repealing the portion of the Housing Bill earlier this summer that dealt with them.  If this bankrupts Fannie and Freddie and results in losses for the debt holders, so be it.
4. Enact policies (both literally and by "jawbone") that force the bad debt in the system out - through bankruptcy if necessary, through pay down if possible.  This sounds cruel and painful.  It is painful but necessary; the key here is to prevent a bond market dislocation, especially in the Treasury Market.
5. As part of #4, force housing prices down so that the median home price returns to 3x median income.  This will produce a monstrous number of foreclosures but that is preferable to the alternative - an economic depression.  Note that these people will not be homeless; there will be lots of empty houses to rent, and rental prices will collapse due to oversupply.  In a couple of years these individuals will be able to repurchase either their home or a comparable one - with 20% down, 36% DTI and a 30 year fixed mortgage, as prices will return to levels where this will be possible.  I understand this is politically difficult but it is necessary; a massive number of consumer bankruptcies sounds bad, but is in fact good, as clearing the bad debt from the system is necessary to prevent its collapse.
6. If the bad debt defaults cause the collapse of the large money-center banks, then Congress should consider the creation of five or ten new banks with an initial capital infusion of $20 billion each, IPOing each immediately and attaching an onerous coupon (e.g. 10%) to the initial capital to strongly encourage its replacement with private capitalization.  This will provide a base lending support of $2 trillion into the economy. However - until #1-5 are undertaken the economy cannot absorb this capacity and therefore it is of no value until that bad debt has been defaulted. 

Everyone is screaming about "increasing credit growth" - including Nouriel Roubini this morning on CNBC.  What Nouriel and the rest who are calling for this sort of "tonic" are missing is that you can't increase credit growth into the market until the existing bad debt has been defaulted as the GDP contribution from additional debt load is dangerously close to going negative, and as it approaches zero you get no economic benefit from doing so.

Attempting to issue new credit (debt) into the market at this time is at best of no benefit and at worst counterproductive.

If that ratio goes negative then you are forced to issue new credit (debt) just to cover interest payments, at which point you no longer can get out of the mess without what amounts to a monetary and economic system collapse.

Those in the media who are chuckling at the folks stockpiling beans and rice will be begging for some of that stash if our government doesn't cut this crap out - and soon.

We may be literally days away from a second, far more serious credit and equity market dislocation, this time originating outside the United States.  

We cannot prevent this second dislocation from occurring but it is absolutely essential that the government "ring fence" Treasury debt before it occurs. 

Government debt must be protected at all costs or we will lose our ability to fund essential services including Social Security and Medicare. 

If Congress fails to act (given that Treasury and The Fed have demonstrated they will tie our sovereign debt to the commercial credit markets to the greatest extent possible) and this second dislocation occurs the probability of an economic Depression rises to 80% or more and the odds of the 2003 market lows holding into 2009 and beyond are essentially zero.

As I see no evidence that Congress grasps the serious nature of this threat and has refused to listen to those of us that have gotten this right from the start, including Nouriel Roubini, myself, Anna Schwartz and hundreds of other commentators and economists, you must prepare for this outcome - and remember who's responsible if and when it occurs.