Editorial

I was wondering how long this was going to take....

NEW YORK, Dec 29 (Reuters) - Morgan Stanley has been sued by a Virgin Islands pension fund that accused the Wall Street bank of defrauding investors by marketing $1.2 billion of risky mortgage-related notes that it expected to fail.

The lawsuit filed Dec. 24 in Manhattan federal court said
Morgan Stanley collaborated with credit rating agencies Moody's Investors Service and Standard & Poor's to obtain "triple-A" ratings for notes marketed in 2007 as part of a collateralized debt obligation (CDO) known as Libertas.

According to the complaint, the CDO was backed by low-quality assets, including securities issued by subprime lenders New Century Financial Corp, which quickly went bankrupt, and Option One Mortgage Corp, then owned by H&R Block Inc.

That's the allegation.... and frankly, my stunner is that it has taken this long for these sorts of lawsuits to show up.

The complaint makes the specific allegation that

 "Morgan Stanley was betting the entire investment it was
promoting would fail," according to the complaint, which was
made available on Tuesday. "The firm achieved its objective."

Oh, who else was doing this sort of thing?  That would be most of the investment banks, right?

The interesting part of this filing from my perspective is that they didn't sue the raters as well.  I'm quite surprised, actually, as one of the places that looks particularly fertile to me in these suits is an argument of collusive conduct between the ratings agencies and issuers.

Why? 

Because if such a case was able to be proved up it would open the floodgates for treble damages via a potential Racketeering suit.  The underlying fraud, if proved, would served as the predicate felony necessary to sustain such a claim.

We're not getting that sort of reaction - yet - but I'm quite surprised.

Among the allegations in the suit are this:

The Dec. 24 complaint said Morgan Stanley knew securities in the Libertas CDO were suffering a dramatic rise in delinquencies, but provided a misleading "risk factor" in a prospectus that rising delinquencies "may" hurt values in the $1 trillion residential mortgage-backed securities market.

It called this representation "analogous to Captain Smith's telling passengers of the Titanic that some ships have 'recently sunk' in the Atlantic and therefore 'our ship may sink,' without mentioning the facts that his ship struck an iceberg, had a hole in it, and was filling with water."

Now that puts the basic premise of the case in a format that everyone can understand.

But what this and similar cases filed thus far seem not to bring up is the fact that the only way these deals made sense (for the issuing bank) was if they were improperly "rated" in the first place!

I go back to the fundamental mathematics of lending and business, as I have repeatedly explained over the last two years and change.  That is, the more people that touch a deal the less money there is available in that deal for the end purchaser.  What this means is that the maximum risk-adjusted return exists when one person loans another money - the more complex the deal gets than that, the less total return the end buyer of the debt, all-in, can obtain - UNLESS SOMEONE CHEATS.

But remember – no matter how you slice this whole deal up only 200 basis points of profit is in there over treasuries to make. You can change who eats the losses and how much the various “fingers in the pie” get to siphon off, but you can’t change the total amount of profit available.

OR CAN YOU?

Wall Street figured out that YOU CAN IF YOU ARE WILLING TO CHEAT.

All you have to do is find someone who will run your “deal” through a computer program and “grade” the quality of its debt. If you can find someone who will claim that the total risk of the deal is lower than it actually is, you make out like a bandit, because instead of 200 basis points of actual profit you suddenly “find” another 50 or 100!

That's the essence of all this "financial engineering."

The problem with suing on this basis is that it's somewhat difficult to explain to a jury how this all worked.  If the jurors eyes glaze over you lose, you see.

I'll make this offer - I'm willing to bet I can spend a half-hour on the phone with any of these attorneys and explain the fundamental scam in these "deals" in sufficiently-clear language that anyone of ordinary competence in the general public can understand it.

That should allow them, in turn, to do so to a jury.

And I won't even charge for my time.

Call me folks.  Seriously.

I have written about "strategic defaults" many times in The Ticker, with the most recent being right here:

Therefore, until the law is changed to prohibit the use of said "Strategic" legal containers and the resulting option of business interests - including the banks that are complaining now - to practice selective default when it suits them I stand by my original view:

Strategic Default, in today's economic, legal and ethical environment, is perfectly within the rights of consumers and they should exercise that right when it makes economic sense, after consultation with both legal and accounting professionals.

This is now showing up in the "mainstream media" - specifically Newsweek:

Um, do any of these people read the Wall Street Journal? Strategic defaults are the American way, and I'm not talking about strapped middle-class borrowers who prefer spending money on vacations to staying current on their payments. Deep-pocketed companies, billionaires, and institutions that can afford to stay current on payments strategically default all the time.

Ding ding ding ding ding.  Give Daniel Gross a cigar!

Let's cut the crap - again - this Christmas, and restate the obvious:

1. Your legal obligations are within the four corners of the document(s) you sign.  No more, no less.
   
   
2. If you, after consulting with legal and accounting advisors, determine that it is in your best interest all in to strategically default on your debts, whether that default be on your mortgage, your credit cards, your HELOC or anything else, YOU SHOULD DO SO.
   
   
3. You have exactly ZERO ethical or moral obligation to NOT exercise each and every legal option available to you, including bankruptcy, suits for quiet title where "lenders" improperly transacted in some fashion or the exploitation of the very fact that lending was done "unsecured" either in fact or in the letter of the agreement.

Yes, there may be consequences.  In some states wages can be garnished to varying degrees, as just one example.  Lenders do have recourse to one degree or another when you make this decision.  It is not so simple as to say "walk away, there's no risk and no cost", because there is both risk and cost.

But the argument that one has a moral or ethical obligation - that there is some "stigma" associated with default - it absolute baloney.

Years ago there was stigma - a man's word was his bond.  But that is gone now, and it is not you, the consumer who made it thus.  It is in fact the very people who lent you that money who made it so - who proffered documents to you written in 4 point type that were impossible for anyone with less than a PhD to understand (and sometimes even then), that contained intentional tricks and less-than-honest inducements, and who themselves were in fact stuffing bogus loans into securities that they then peddled out to the masses!

Janet Tavakoli has once again opined on this in relationship to Goldman Sachs, which was, as you're no doubt aware, one of the firms that packaged up HELOC and other "household debt" to be sold off.  Here is what she said in that column:

The answer is that they sold a lot of "hot air" disguised as valuable securities. Goldman claims this was prudent risk management. In reality, Goldman created products that it knew or should have known were overrated and overpriced.

If Wall Street had not manufactured value-destroying securities and related credit derivatives, the money supply for bad loans would have been choked off years earlier. Instead, Wall Street was chiefly responsible for the "financial innovation" that did massive damage to the U.S. economy.

Got it?

You got that "loan" because these institutions provided it to you knowing full well that you could not pay.

That is, they didn't loan you money expecting you to pay them back, they lent you money knowing you couldn't pay, sold off loans they knew were bad to other people AND THEN BET AGAINST YOU PAYING!

I will counsel in these pages that you should pay your debts if and only if and when:

• Those who made intentionally unsound loans are indicted, prosecuted and imprisoned for their willfully-fraudulent lending.
  
  
• Those who packaged up these loans by stuffing bad loans into paper then sold and resold by others in an orgy of intentional misdirection and fraud are all forced to eat their own cooking, instead of the taxpayer bailing them out.
  
  
• The laws are changed so that the practice of both intentionally-unsound lending and strategic default is handled identically for both "big corporations and rich folks" as well as for the ordinary working stiff who is trying to hold his head above water.

In other words I will change my tune if and only if and when those who destroyed the social contract of a man's word being good on its face change THEIR tune.  Until that time it is my assertion that you are not only within your rights to deal with them as they deal with you BUT YOU HAVE A MORAL AND ETHICAL OBLIGATION TO DO SO AS IT IS THE ONLY MEANS AVAILABLE TO THE COMMON MAN SHORT OF UNLAWFUL VIOLENCE TO STOP THE SCAMS!

Let me be clear: There is no argument to be made whatsoever in the current environment for a "moral or ethical obligation" to pay your debts.  Those debts were incurred in an environment where asset prices (which you used that debt to finance) were fraudulently inflated in "value" through the intentional concealment and bogus "underwriting" and packaging noted above.

This bogus underwriting as I and others have noted was not an accident, it was a means of looting the public both explicitly at the time and then later via taxpayer bailouts - these so-called "profits" were bonused and paid out via dividends and rising stock prices when in fact the "earnings" that led to same were a phantom, an artifice and a fraud!

You and I - ordinary Americans - did not make it thus.  We did not create these value-destroying "assets", we did not pollute allegedly good paper with loans we knew could not be paid, and we did not glibly sell assets to people in one part of our personal financial operations, claiming they were "money good", while shorting them in another.

The ENTIRETY of the fraud-laced economy is holding together by one and only one singular thread at the present time: the fraudulently-peddled LIE that you have an obligation to deal at some sort of ethically or morally superior level with a band of brigands, scam artists and fraudsters.

YOUR fleecing will end ONLY when you, the ordinary American, decided you will NOT deal "honorably" with a den of vipers, but instead deal with them exactly as they have dealt with you, and your attitude will change ONLY when theirs does and they make recompense for their past sins.

YOU, America, decide how long you want these firms to screw you on a literal daily basis. 

YOU can stop it tomorrow.  If every American decided to default - on purpose - on their credit cards and mortgages, each and every one of these institutions who has screwed you for the last two decades would be rendered insolvent in less than one month's time.

YOU have the power America.

Will you use it or continue to cower in the corner before those who, as I have written about for the last two and a half years, have exploited your gullibility and "ethics" to force you into near-literal slavery?

THAT is the question facing you this Christmas.

Well well well...

Tim Jones, parish priest of St Lawrence and St Hilda, told his congregation in York, northern England: "My advice, as a Christian priest, is to shoplift."

Jones, who according to the church Web site previously worked in Corinth, Mississippi, made his comments about what he regarded as acceptable behavior by those in need when they were desperate.

In a transcript of his sermon published in the local newspaper, "The Press," Jones said: "I do not offer such advice because I think that stealing is a good thing, or because I think it is harmless, for it is neither.

"I would ask that they do not steal from small family businesses, but from large national businesses, knowing that the costs are ultimately passed on to the rest of us in the form of higher prices."

That sounds rather un-Christian.

Or is it?

Let's examine this a bit.

We have a society that allegedly has laws that we all must follow.  They include the general premise of not screwing people: honest and fair dealing, disclosure of material facts you know would influence another's decision to do business with you - and certainly, an expectation that you would not intentionally misrepresent the truth.

So what has happened over the last 20 or 30 years when it comes to business, banking and credit?

• The Federal Reserve has intentionally held liquidity - that is, "excess cash" in the system, too high for extended periods, even though this was intended to and did produce multiple asset bubbles.
  
  
• Officials from The Fed (and others) made statements that were reckless in their disregard for the truth.  Claims that housing prices reflected "sound fundamentals" where homes were selling for two or even three times sustainable prices are just one of many examples - even when prices were taking on 20, 30, or even 50% gains in a year.
  
  
• Greenspan claimed there was "irrational exuberance" in the stock market but then did absolutely nothing about it for the succeeding four years!  The result was a huge stock market bubble in Nasdaq stocks that subsequently burst.
  
  
• Investment and Commercial Banks willfully and intentionally made loans to people who they either knew could not pay (other than by refinancing into another loan) or worse, simply didn't give a damn if you could pay or not - because they assumed they would simply steal the house!
  
  
• This wasn't limited to houses - it was found in literally every sort of lending and commercial activity.  PIK/Toggle bonds, "covenant light" loans, leveraged buyout money, all of it was the same basic scam - we don't care if you can pay because we will unload this garbage on some other bagholder before it all blows up!
  
  
• Some borrowers got involved in the fraud machine too. Why tell the truth when you can "state" that you make $200,000 a year - cutting hair!  Why if you want that million dollar house and can get an OptionARM at 2% interest-only (against a real rate of 6%) for the first two years, go for it!  You can always refinance before the "teaser" expires, right?

Now if this was just some banks screwing each other, so what?  If it was just speculators in the markets playing with one another, who cares?  All consenting adults playing "stick that hand grenade down the other guy's pants before the fuse runs out", right?

Wrong.

What happened to the price of houses?  Milk?  Gasoline?  Steak?  Health insurance? What happened to the prices that people who had no hand in the fraud had to pay - as a consequence of the fraud?

What happened to all the good jobs?  All these asset bubble games forced profit margins inward, which in turn created the incentives to offshore production.  And offshored it was - to China, where virtual slave working conditions were and are the rule, destroying white and blue-collar jobs alike - including most especially those who had nothing to do with the frauds during these years!

So now we find ourselves with a situation where the wealth of entire nations have been looted.  This wasn't an accident, it wasn't an oversight, it wasn't happenstance.

It was a series of intentional acts, and along the way a literal million felonies and other improprieties occurred.  From the "homeowner" who lied about incomes to the Real Estate "professional" who leaned on an appraiser to "hit a number" to the seller and buyer who colluded to kick back money and inflate a purchase to the lender who "helped" a buyer fraudulently overstate their income to the "securitizer" who had 1003s for their loans but failed to verify tax returns (and couldn't have possibly believed that a Greeter at WalMart made $200,000 a year!) to the ratings agencies that ran no scenarios in which home prices would ever decline.

Let's just take one example: AIG.

How does a company write literal hundreds of billions of dollars in "credit protection" while having almost literally ZERO capital to back up those bets?  Who knew that, when, and why was that "business" (of making legally binding promises they knew they could not keep) allowed to proceed?

There are and were hundreds of AIGs.

NOT ONE OF THESE ACTS IS CURRENTLY UNDER INDICTMENT, NOT ONE DOLLAR HAS BEEN CLAWED BACK AND NOT ONE OF THE PEOPLE RESPONSIBLE FOR THIS IS IN PRISON. 

So now as a consequence the common man loses his house, his job, and 30% or more of his retirement account.  In addition the price of gasoline has doubled, his health insurance costs have gone up by 500% in the last 20 years and the food bill has gone from $100/month to $250.

What is this person supposed to do?

The entire premise of a polite and law-abiding society is that while not every crime can possibly be punished vast, pervasive fraud and robbery will not stand.  The government's job is, if nothing else, to prosecute such wrong-doing and put a stop to it, clawing back what can be recovered so the victims receive whatever compensation is possible and the wrong-doers are punished.

YET THEY HAVE REFUSED.

So is it, under such conditions, REALLY wrong to go take what one needs to avoid outright privation - or worse, starvation?

Does the government understand the risk they are running by willfully refusing to act as the law demands? 

To remove people from office, to prosecute wrong-doing, to lock these crooks up?

If the people cannot find justice within the government's apparatus, are they to sit quietly and ask "Please Sir, may I have another (beating, rape, robbery, take your pick)?"

Or should we expect that at some point - perhaps not now, but perhaps not far down the road either, the people will have had enough.  They will rise and take care of these matters in their own way - and there won't be much in the way of a "fair trial."  I've yet to see boiled rope or guillotine blade futures listed by the CME, but is this sort of redress for grievances really that far in our future? 

There are times I wonder.

Perhaps the reason we have not seen a massive uprising - and the institution of "citizen trials" - is that the American People simply don't get it.  They never learned compound interest and earnings in school, as it is simply not taught.  Tout TV never talks about the total systemic debt load and how it has grown (as I posted in The Ticker a few days ago) .vs. GDP.  The truth about The Fed basically paying people to borrow (we have real negative interest rates right now!) as a means of trying to intentionally inflate bubbles is never discussed.

Intentional?  Probably.

For how long will The People remain in the dark?

Are they ignorant - or stupid?

Ignorance can change in a day, or a week - with catastrophic results.

To both State and Federal Government Officials: I know I have said this before, but I will repeat it - The lawless actions of the past 20 years must not be allowed to stand - you must not allow The People to discern that you are a felon rather than a cop.

To Father Jones: While I cannot square your advice with The Ten Commandments, I am reminded that The Bible tells us that even Jesus had his limits when it came to those Commandments, and the one time he exceeded those limits was with THE MONEYCHANGERS in The Temple.  The very same robber barons - of the time - who were cheating the people.  My, how similar the situation seems to be.

To The People: Wake the hell up.  Demand prosecution. Back that demand up with your vote, and while you're at it, pray that this is enough, for if it is not, where your neighbor or countryman who has lost everything may turn is a dark place neither you or I wish to see our nation descend to.

You have to admire the chutzpa displayed by the ECB....

VIENNA -- The European Central Bank won't bail out debt-stricken member states such as Greece, which must repair its public finances on its own, ECB governing council member Ewald Nowotny said.

"One has to be very clear: The ECB has no mandate or intention to take into account the situation of a specific country, especially not with regard to public finances," he said in an interview late Friday.

This of course is in comparison to all the banks that the ECB has bailed out, including most recently in Austria, irrespective of their idiocy expressed in unsound lending - even lending across borders in other currencies!

This of course exposes the borrower to currency (exchange rate) risk, and you can count the number of ordinary people who are competent to manage that on the fingers of one hand.

Then when it blows sky-high who gets the bill?  You!

What's particularly galling about the Austrian bailout is that they knew damn well - or certainly should have - that it would blow ski-high.  Indeed, there were stories in the media more than a year ago highlighting the risks.  This was not a surprise to anyone - and if the ECB had a lick of common sense they would have required these banks to de-leverage this risk back then.

Of course they didn't, just like our so-called "regulators" didn't require the commercial real estate risks to be taken down in the US - even though we knew more than two years ago - I was writing about it as were others - that this was going to be a disaster.

But back to Greece:

Greece has promised to reverse a severe slide in its finances. Right now, it is on track to report a fiscal deficit equal to 12.7% of gross domestic product for 2009, well above an European Union-mandated ceiling of 3% of GDP. This weekend the Greek parliament began five days of debate on the government's 2010 austerity budget, which aims to narrow the gap to 9.1% of GDP next year.

The US is running over 10% of GDP for deficits "officially", and closer to 20% if you include all the off-book crap that we don't bother counting (and if you did in a private company would land you in the hoosegow.)

So exactly what sort of "fiscal austerity" are we enacting here in the US?  Oh let's see - how about a huge entitlement system change ("Health Care Reform") that by some estimates (including the CBOs!) will add further to our budget deficits!

Never mind that Bernanke and The Fed are the handmaidens of Congress in this regard.  His monetization activities have explicitly supported and enabled these deficits - and driven away foreign investor interest.

Reality is that none of the so-called "regulators" - worldwide - have any interest at all in prudent lending.  Why not?  Because prudence in lending, leverage ratios that are actually enforced and mark-to-market restrict bank profits - that is, the amount of GDP that banking institutions of all sorts can extract from the economy and transfer out to the "privileged class" via so-called "proprietary trading" and bonuses.

Indeed, this is where government and regulatory interests align to the detriment of economy stability: Governments want to see big GDP increases, and increasing leverage (amount of borrowing outstanding in the economy for a given GDP level) is one way to do this.

The best way to control this trend would be to mandate (by law) that GDP be adjusted to reflect leverage changes in the economy - that is, if debt goes up by 4% of GDP then the 4% has to come off the reported GDP numbers.

That would stop the BS immediately - which, of course, is why it won't happen.

Don't believe the hype - it is increased leverage over the last 30 years, as I have identified in The Ticker since 2007, that has driven our so-called "strong economic growth."

Now the check for our profligacy is on the table and the waiter is tapping his foot.

This sort of crap really pisses me off:

In answer to a question about why rising debt is a concern, Greenspan said: “The critical issue that economists worry about” is the spiral that occurs with ever-rising debt and debt service, often followed by higher interest rate. As a consequence of that, “the debt service becomes explosive and that moves directly into the budget deficit,” he added.

Yeah yeah. If you read his testimony what you will find missing is any acknowledgment of exactly how it is that government gets the idea that it can run more than a trillion dollars in deficits in the first place!

I'll tell you how, since "Sir" Alan won't: You find a central banker that will kneel before Congress whenever the members drop their drawers by pumping so much liquidity into the system that real rates are in fact NEGATIVE, thereby LITERALLY paying people to borrow.

Of course the government has never met a free money handout it didn't like, and political will for restraint is ZERO when faced with such a circumstance.

The solution to this is really quite simple: Don't do that sort of stupid crap!

We continue to challenge Einstein's General Theory of Insanity - you know, one of my favorite definitions?

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

Greenspan was the architect (with Bernanke's goading) of the "extended" 1% interest rates in the 2000-2003 time period, and now we're at ZIRP.  But it didn't stop there!  Bernanke went even further and monetized $300 billion of Treasury Debt and is on track to monetize $1.2 trillion of Fannie and Freddie paper, thereby effectively "negating" (for the purpose of the government) $1.5 trillion of government spending.

Of course this is all a bunch of arm-waving BS - you can't "negate" such a thing, you can only shift where the damage falls.  And fall it will - in this case, right on the value of the currency.

The real question Greenspan should have raised (but didn't) is where the line is on capital flight - exactly how far we have to go before the dollar loses all credibility in the international markets.  Continuing to try to monetize our way out won't work, and Bernanke appears to understand this in that the latest FOMC statement rather forcefully says "yes we really are shutting it all down come February."

We'll see about that.

My concern isn't so much whether the "extraordinary programs" go away.  It is whether Bernanke will put a stop the Treasury issuance - a stop that must come sooner or later. 

He must realize, as do I and anyone else who cares to look, that the game has been lost.  The gambit taken in 2007 was that The Fed and Treasury could temporarily "stand in" for consumers and restart credit expansion. 

This gambit has now failed, as the below chart shows conclusively:

There is no way out of this mess that does not involve deflation.  Specifically, the debt outstanding must deflate.  This will in turn deflate prices in the market that have been overblown - in houses, in education, in public service.  It will deflate lots of multi-million dollar bonuses and fatcat pension payouts too.

I fully realize that nobody in government wants to see that happen.  But it doesn't matter what people want at this point - we have only two choices: no durable economic recovery and the possibility of an economic and government funding failure, or accepting the consequences of deflating the debt bubble.

Those are the only two options.

The 900-lb Gorilla that stomped his first piece of china was found in the $290 billion debt limit increase - something that AP reported (perhaps accidentally):

Republicans - who helped supply votes to increase the debt ceiling just last year - unanimously opposed the legislation, which is required to issue new debt to pay for federal operations and deposit up to $50 billion into the Social Security trust funds.

Uh, Social Security wasn't supposed to go negative - that is, require actual general fund expenditures - for another 20 years!

But now it was - and that's a major problem.  How much is Social Security and Medicare actually in the hole here?  I don't know - but the fact that we're 20 years in front of where we should be in this regard is very ominous.

I realize that the government has a political aversion to the concept of austerity.  I realize that making promises with money you can borrow today and pay for never has become the American Way Of Life^tm.  But this sort of nonsense - this mathematically impossible path - cannot continue forever, and Americans in general have hit the wall.

Government has done its level best to extend, pretend and lie. 

We are out of the ability to do all of the above.

The Fed must withdraw its liquidity support.

Congress must stop spending money it does not have.

These two actions will not occur without pain.  But the pain will come whether we take these actions or not.  We have gangrene in our hand, and it is progressing up our nation's arm.

We could have cut off the middle finger, where it began, in 2001 and kept the rest.  We did not.

We could have cut off the hand at the wrist in the summer of 2007, when I first identified the games being played with bank balance sheets, and kept the rest of our arm.  We did not.

We can cut off the arm at the elbow now, and keep the upper arm, as disfiguring as that may be.

If we do not, and the gangrene gets beyond the shoulder, it will no longer matter.