The Market Ticker - Editorial

A Random Look at RMBS And The Economy

nospam@example.com (Karl Denninger) — Tue, 09 Mar 2010 13:22:00 -0500

Bond Cusip                    60+
ACCR 2007-1 M2 00438QAF1      35.8
CARR 2007-RFC1 M2 144526AF7   48.5
CMLTI 2006-WFH3 M1 17309QAE4  40.3
CWL 2006-10 MV2 12666PAW4     61.0
CWL 2006-18 M1 23243WAE8      60.5
CWL 2006-20 M2 12667HAG6      62.4
CWL 2006-22 M2 12666BAG0      60.2
CWL 2006-25 M2 12667TAG0      62.9
CWL 2006-26 M2 12668HAG5      60.0
CWL 2006-3 M1 126670WC8       57.4
CWL 2006-BC4 M1 12667NAE8     64.6
CWL 2007-1 M2 23245CAG5       64.4
CWL 2007-10 2M1 23246BAM3     56.6
CWL 2007-10 2M2 23246BAP6     56.6
CWL 2007-10 2M3 23246BAR2     56.6
CWL 2007-10 M5 23246BAT8      56.4
CWL 2007-11 2M3 23247LAK4     56.6
CWL 2007-11 M5 23247LAM0      56.3
CWL 2007-7 M1 12669VAF5       56.2
CWL 2007-8 M1 12669WAG1       57.0
CWL 2007-8 M5 12669WAL0       57.0
CWL 2007-9 M1 12670FAF7       57.9
CWL 2007-9 M2 12670FAG5       57.9
CWL 2007-9 M3 12670FAH3       57.9
CWL 2007-9 M5 12670FAK6       57.9
JPMAC 2006-CH1 M2 46629TAG5   37.6
JPMAC 2006-CH2 MV3 46629QAZ9  47.5
JPMAC 2006-CW2 MV2 46629BAU3  65.5
JPMAC 2007-CH2 MV2 46630MAY8  42.2
JPMAC 2007-CH2 MV4 46630MBA9  42.2
JPMAC 2007-CH3 M1 46630XAG3   46.5
JPMAC 2007-CH3 M2 46630XAH1   46.5
JPMAC 2007-CH3 M3 46630XAJ7   46.5
JPMAC 2007-CH4 M1 46630CAF1   42.9
JPMAC 2007-CH4 M2 46630CAG9   42.9
JPMAC 2007-CH4 M3 46630CAH7   42.9
JPMAC 2007-CH5 M2 46631KAG0   46.6
JPMAC 2007-CH5 M4 46631KAJ4   46.6

A random assortment of 2006 and 2007 securitizations from our friends at JP Morgan and Countrywide (mostly.)

The last number is the 60+ delinquency percentage.

A lot of this is Home Equity lines.

Remember my Ticker yesterday and my rant on Blogtalk regarding Barney Frank and the outrageous hidden losses being carried by our banks? That none of this is being pursued, yet every week we see proof of it in FDIC bank seizures and the loss ratios? That this sort of book-cooking, were you or I to engage in it in a public company, would lead us to be criminally charged, and in fact this is exactly what Ken Lay and Jeff Skilling were charged over doing?

Folks, this is endemic through the financial system. The best performing issue in that list has a 60+ delinquency rate of 35.8% and a material number of them have more than half the loans in hard default.

Every home equity line behind an underwater first that is also not being paid is worth zero. There is no recovery. This is not like most bonds, where there is a meaningful recovery percentage after the default happens. This is subordinated debt that is worth exactly bupkis if the senior lien cannot be fully satisfied from a foreclosure on the property.

These bonds are literally everywhere. They're in pension funds. They're on bank balance sheets. They're held by The Fed through the garbage Fannie and Freddie paper they bought. Foreign governments and foreign banks hold them.

Yet we have banks that are carrying very similar portfolios of loans on their books - second liens, either home equity or "silent seconds" used to get around various ratio requirements such as PMI on loan origination, and essentially none of them are being carried at anywhere close to these levels of loss.

There has been no - and I do mean no - recovery of balance sheets in the United States when it comes to financial companies, pension funds or anyone else holding this crap. Zero. Zip. Bupkis.

Servicers have in some cases, it appears, even co-mingled funds in order to advance coupon payments, which has the effect of hiding these delinquency rates from investors.

For a while.

Cash flow always wins though folks.

I continue to hear "look, the market has a year under its belt now from the low, this means that it's a long-term bull market and will go higher for years to come."

Ok, let me ask you one question, and I will not provide the answer: You will, by doing your own work, because if you don't, then you won't take responsibility for your own outcomes - and if you're in that camp then stop reading The Ticker right now and start watching Jim Cramer on CNBS.

In every previous recession and market swoon post WWII by the time we have gotten a year from the bottom whatever it was that ailed the economy going in had been resolved. Let's go through a few of them:

The S&L crisis, at this point, was under control - the S&Ls were under FDIC control, people were being sent to prison by William Black (and others), and we had a dimension on the losses and who had done what to whom (those loss estimates turned out to be way low, but at least we knew where they were.)

In the 1970s by this time oil prices had relaxed and the risk of the embargo was over.

Post-1981 recession interest rates were on their way down; the back of inflation had been broken.

Post early-1990s the California military bubble had popped and was mostly mopped up.

By the end of 2003, most of the Internet companies that had no business being in business were gone and buried; their bogus claims had led to their demise, and they had filed bankruptcy.

Now let's contrast this with today:

The credit default swap monster has not been caged. In fact, there has been no change whatsoever in how these are traded and written. Nor has anyone in the banks been indicted even when there is evidence of blatant bribery (as in the case of Jefferson County Alabama.)

All of the large banks, and a lot of mid-sized banks have enough second line exposure on their balance sheets written in the bubble states, carried at or near full value, to severely damage their capitalization ratios if not outright force them into receivership. Not one of these institutions is marking their second line exposure anywhere near what the delinquency rates in these securities implies about their recovery values. Yet these losses are both real and the overwhelming evidence says that impairment is permanent.

Existing home sales numbers have flattened at an extremely low level, even with the $8,000 tax credit. This implies that the value of this credit has been reached in the marketplace, and that no actual recovery in housing is or will take place in the near term. Yet the entirety of the premise that the economy has turned the corner - some 20% of GDP is housing related - rests on the belief that it has.

We are told that the auto industry has "recovered" with an estimated annual sales rate of 11 million cars. The peak of the auto production cycle was seventeen million. Even if half of that is recovered it will leave some 17% of that capacity idle and those people who used to man it unemployed. Where are they going to go for jobs?

The labor employment rate (of all employable adults) is back to levels last seen when we had less than half the consumer and industrial debt in the system we have today as a percentage of income. This sort of job loss into ramping debt has never happened before in the post-Depression era. How are the interest payments going to be made?

The lockup in credit markets and economic malaise that followed occurred as a direct result of fraudulent balance sheets - that is, claims that firms had liquidity and assets that in fact were false. When that falsehood was unmasked they failed instantly, as occurred with ENRON and MCI. Do we, today, have balance sheets that accurate reflect the valuation of all assets by firms across the economy - not only in banks, but also in firms like GE and CISCO?

The government is literally providing 9% of GDP via deficit spending that exceeds the records set during the 2003-2007 years. That is, they've replaced a full nine percent of the economy's final demand since 2007, and despite the claim that the economy is recovering the amount of replacement activity they're supplying has increased since the spring of 2009 and continues to do so. If the government is going to supply this replacement for the indefinite future and that is necessary to avoid the recognition of an instantaneous economic Depression (defined as a 10% contraction in GDP) can the government continue to do so on an indefinite forward basis?

The entirety of the market rally from March of 2009 to today, and its sustainability on a forward basis, is dependent on the above - especially the government being able (and willing) to continue in its new role of providing 9% or more of GDP (beyond what it used to provide!) along with the continuing ability to mark assets that are worth little or nothing well above their actual market prices.

DO YOU BELIEVE that this can and will occur on an indefinite forward basis?

If you do, then you should be fully invested here and now, because indeed, profits will continue to advance, revenues will continue to advance, and the market will continue to advance. We have a new bull market predicated on The Government legalizing balance sheet fraud and indefinite forward support of nearly half of GDP all-in (add up State and Federal spending - its close to 50% of GDP), with the additional 9% added for the last two years continuing into the indefinite future (and likely expanding too, especially with "health care" reform.)

If you do not then you should be hiding under the desk, because just as occurred in 2000 and 2008 when the breakpoint comes it will occur without warning, without recourse, and without the ability for you to get to the exit in time, and since the amount of the fraud and bogosity exceeds both the 2000 and 2007 levels by far so will the reaction - when it occurs.

When The Gun Is In YOUR Mouth.... (CDS / Merkel)

nospam@example.com (Karl Denninger) — Tue, 09 Mar 2010 10:14:00 -0500

... suddenly politicians "get religion" about making damn sure it has no bullets in it:

“We’re of the opinion that a quick implementation of actions in the area of CDS has to happen,” Merkel said. Citing “ongoing speculation against euro-region countries,” she called for the “fastest possible” implementation of new rules. Europe must “do everything to avoid unhealthy speculation,” said Juncker, who heads the euro-area finance ministers group.

Where 'ya been Angie?

Oh, and you too Papandreou:

“Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system,” Papandreou said yesterday in a speech in Washington.

And, of course, Sarkozy.

Note that I've been calling for these things to be either exchange-traded with central counterparty "blinding" (on purpose) as is the case with the regulated option and futures markets or be torn up since The Ticker began publication.

Why? Because it is my position and remains so that unless you have this sort of market these contracts are all a scam.

They are a scam because:

The counterparty cannot pay in aggregate for the exposure they have on. This, in turn, "allows" them to write these swaps at an uneconomic price, which means that in effect these are all "side letter" deals. That is, they're intended to cheat regulatory capital requirements as everyone involved knows there is no possibility of actual performance. In these cases everyone involved should be rotting in prison - the buyer for purchasing a knowingly-bad "insurance policy" against an event that they know can't pay off for the singular purpose of defrauding a government regulatory agency (and/or the shareholders!) and the seller for putting forward a contract they know they are incapable of performing on.
The entire purpose of off-exchange trading of these instruments is to severely-damage the purchasers of these swaps in the retail market by obscuring the essentials of the transaction, including the bid and offer from other participants. This also has the effect of allowing collusion, either active or passive, among sellers - nearly all of which are big banks and financial institutions. This collusion, by the way, either is or should be a felony violation of anti-trust laws. Finally, concealment of the market's opinion on price and activity allows outright bribery and other very-unlawful acts such as allegedly occurred in Jefferson County, Alabama.

The solution to this is simple, it's elegant, and I've been railing about it since The Ticker began publication, but there's no time like the present to re-state the demands and make sure they're clearly communicated to everyone.

In short, we must make all of these derivatives, including interest rate, currency and credit swaps:

Trade on public exchanges where blinding of counterparties takes place. This is exactly identical to what is done with the OCC for listed options and the CFTC for listed futures. If I buy a PUT on a company I have no idea who sold that PUT in the market, and further, if I exercise a long PUT the person who originally sold it may not be the one who gets assigned - that's handled by lottery among all who are short that contract. This makes abuse of these contracts by the buyers, who then seek to destroy the sellers, extremely difficult as they have no idea who to target.
Have the exchange is the buyer for every seller and the seller for every buyer. Since the transaction is effectively "blinded" from the counterparties the exchange is thus in the position where it must make certain that anyone who is short has the capital posted and held as margin to guarantee performance or the exchange will wind up insolvent. The exchange has nothing to gain and everything to lose by allowing people to "game" collateral and margin requirements - thus, it doesn't happen. Further, as volatility rises the exchanges tend to increase margin requirements in order to protect themselves against sharp and unexpected moves - exactly what would be expected of a prudent counterparty. In short this process makes the market "safe" for both buyers and sellers, and even in times of extreme stress such as the 1987 crash nobody has ever had a regulated futures or options contract fail to be honored.
Break up those "custom" contracts that are so esoteric that only a handful of people want to trade them into standardized contracts that a lot of people want to trade. Let's say that someone wants a custom derivative that is comprised of the price of oil and the price of John Deere's stock. Perhaps they're a major farming interest that is concerned not only about the possibility of Deere failing (they have combine orders stacked up that would be VERY expensive to replicate on the spot market) but also the price of oil since they have to fuel those combines. That's a custom contract that almost nobody would want to trade, but it can be deconstructed into a PUT on John Deere and a short on the oil futures. In essentially every case these "custom" contracts can be deconstructed into two or more things that lots of people will want to trade, which immediately destroys the argument for "custom" OTC contracts.

For those financial parties who "resist", the solution is simple: either relent or those contracts which you refuse to migrate to such an exchange are torn up as void ab-initio as you have refused to demonstrate both ability and intent to perform. They are thus not valid contracts - end of discussion. If the buyer wishes they can (and should) go sue to seller for return of their premium, since they bought something that was sold under false pretense.

Congress must take this action now, and if it will not, then the executive must by whatever means are necessary - including executive order. It's all the better if Merkel, Sarcozy and others on the world stage have finally come to realize what I've been saying now for the last three years when this mess first began:

These over-the-counter derivatives are an outrageous-destabilizing force and, in many cases, are outright fraudulent instruments as the selling entity lacks the capacity to perform as agreed.

The essence of the AIG mess was that the company lacked the financial capacity to perform. It really is that simple. Knowingly entering into hundreds of billions of dollars of financial commitments without the ability to perform should be treated as a felonious act, but apparently we have no cops anywhere in the world interested in massive and outrageous acts of this sort, as I have yet to see hundreds of perp walks up and down Wall Street.

Well, if the next-best thing is to prevent it from ever happening in the future, I guess we'll have to settle for that - even though it is, on balance, wholly-insufficient when one considers the damage that these people have caused to the global economy and financial system.

Sheepskins Should Stay On Foreskins (Galbraith)

nospam@example.com (Karl Denninger) — Mon, 08 Mar 2010 10:13:00 -0500

In this case, on Galbraith father's foreskin. We would have been spared this intellectually-bankrupt and fallacious bit of spooge:

The Simpson-Bowles Commission, just established by the president, will no doubt deliver an attack on Social Security and Medicare dressed up in the sanctimonious rhetoric of deficit reduction.

....

But what would be the economic consequences if they did? The answer is that a big deficit-reduction program would destroy the economy, or what remains of it, two years into the Great Crisis.

Now that is Grade "A" hyperbole. Let's examine it and see if there's any reasonable basis behind the claim.

To put things crudely, there are two ways to get the increase in total spending that we call "economic growth." One way is for government to spend. The other is for banks to lend. Leaving aside short-term adjustments like increased net exports or financial innovation, that's basically all there is. Governments and banks are the two entities with the power to create something from nothing. If total spending power is to grow, one or the other of these two great financial motors--public deficits or private loans--has to be in action.

Well, no.

There is only one way to get an increase in total spending that is sustainable: you must increase net production of "stuff", whether that is goods or services.

Wealth is not debt. It is production. It can only be mined, manufactured or grown. The only free lunch that is available is the power of the Sun, and that's only 'free" because we are too puny to measure in astrophysical time scales (if we weren't we'd realize that even the Sun's energy is in fact neither free or inexhaustible!)

With government, the risk of nonpayment does not exist. Government spends money (and pays interest) simply by typing numbers into a computer. Unlike private debtors, government does not need to have cash on hand.

.....

But no government can ever be forced to default on debts in a currency it controls. Public defaults happen only when governments don't control the currency in which they owe debts--as Argentina owed dollars or as Greece now (it hasn't defaulted yet) owes euros. But for true sovereigns, bankruptcy is an irrelevant concept.

That's the biggest load of bilge I've read in years.

While it is technically true that a government that has control of its own currency can print as much as it wants, it is not true that printing that currency with wild abandon is cost-free, and the more inter-connected one's economy is with other sovereigns that also have control of their currency the more dangerous unbridled printing is.

Weimar Germany had control of their own currency, and we all saw what happened to them.

Nor is public debt a burden on future generations. It does not have to be repaid, and in practice it will never be repaid.

This is true but also intentionally misleading.

The issue is not whether the debt will be paid off - it is that the interest payments are not under the issuing nation's control. Demanded rates are a function of perceived ability to tax from the citizens the revenue necessary to cover that interest coupon.

Due to inefficiency in the economy (again, back to thermodynamics principles - no transfer of anything is ever 100% efficient) the money "printed" will fail to be entirely transmitted to the citizens in a form and fashion that can be taxed. Indeed, they must spend some of it in order to survive. This leads less than all of it available to be taxed away to cover those interest payments.

Nor is that interest a solvency threat. A recent projection from the Center on Budget and Policy Priorities, based on Congressional Budget Office assumptions, has public-debt interest payments rising to 15 percent of GDP by 2050, with total debt to GDP at 300 percent. But that can't happen. If the interest were paid to people who then spent it on goods and services and job creation, it would be just like other public spending.

Galbraith assumes that the interest is owed to US Citizens. It is, to a large degree, not. Those interest payments drain the economic vitality and future of the nation to foreign nations, as a vampire drains its victims blood.

So the fact that we're buying a lot of goods from China simply means we have to be more imaginative, and bolder, if we want to create all the jobs we need.

Really? How does one compete with a wage of $1/day (in yuan, of course)? Why by destroying one's standard of living, that's how. This in turn destroys the tax base and we're right back where we started - without the ability to pay interest except by destruction of the currency, which in turn forces the cost of imports higher.

That in turn ruins the citizen's discretionary purchasing power as the most-sensitive import to currency depredation is petroleum, which we (due to our own idiocy over the course of more than 30 years) are effectively forced to purchase from foreign interests.

But petroleum is in literally everything. It is not only in things that are obvious (e.g. gasoline and fuel oil) but is an essential component of literally everything we buy. Our modern food production system is dependent on petroleum for planting, fertilization, irrigation, harvest, processing and transportation. Every item in your home or office that contains plastic or rubber contains petroleum, from the wrapper for your meat at the grocery store to your computer monitor, television set, the shingles on your roof and the tires on your car (not to mention its interior!)

But right now, we don't have functional big banks. We have a cartel run by an incompetent plutocracy, with its long fingers deep in the pockets of the state. For functional credit to return, we'll have to reduce the unpayable private debts now outstanding, to restore private incomes (meaning: create jobs) and collateral (meaning: home values), and we'll have to restructure the big banks.

You can't restore that which wasn't there.

Home values were false - fraudulently so. They were pumped by charlatans pushing cheap credit and bogus appraisals. The utility value of a home is to give you a place to hang your hat, take a dump and stick your bed where you won't be eaten by mosquitoes while you sleep. This value is, and should be, able to be purchased for an average family for the price of somewhat near or less than one year's family wage, free and clear, without ongoing tax encumbrance. Consider this: What did the settlers of this nation have to pay for their house? On the prairie they were "raised" by the local community in a day or two, then finished by the family over time. Were there 250 man-days that went into raising such a house? Nope. Yet that's the definition of one year's family income, right?

Over time we have thought of homes as financial assets, but they're not. They're shelter. They perform an essential function and as such allowing the nation's banks and other financial wonks, like Galbraith, to get their teeth into them has been incredibly lucrative - for the wonks. For the rest of the nation it has spelled ruin every time it has occurred - 1873 (and before), 1929, and now in 2007. In each case "real property" became the object of monstrous speculative froth unrelated to the utility value of the asset, and in each case economic malaise inevitably followed.

We need to break them up, shrink the financial sector overall, expose and prosecute frauds, and create incentives for profitable lending in energy conservation, infrastructure and other sectors.

That indeed is necessary. But doing so will inevitably cause the speculative froth to come out in all of these asset classes. Homes will contract to no more than 3x incomes on average, and likely lower. If we contract homes to utility value they'll shrink in price to between 1x and 2x incomes, and property taxes will disappear.

This, of course, is anathema to federal, state and local governments, not to mention the very institutions that were responsible for the speculative froth and fraud. It is therefore perhaps a bit disingenuous to call for that which you know must happen while at the same time stating that we must restore bubble values to certain asset classes, for both cannot happen at the same time.

Either way, until we have effective financial reform, public budget deficits are the only way toward economic growth.

Deficit spending is not economic growth. If I lose my job and use my credit card to sustain my lifestyle, I have not experienced "economic growth." Quite to the contrary, should I represent to anyone - including myself - that my economic situation is stable or improving through such a display of abject stupidity all I have done is perpetrate a fraud upon those who I communicate such a claim to.

The sort of vacuous nonsense that Galbraith displays is why we're in this mess. For the good of our nation this sort of stupidity must be banished in favor of embracing the truth: we have not lived in a nation of economic progress based on innovation and production for three decades, and we cannot return to a stable economic condition until the speculative froth - and the debt it engendered - is removed from our financial and economic system.

Paul Krugman's Universe of Stupidity

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 08:25:00 -0500

Krugman sharts once again with an amazing bit of partisan hackery:

But while the blockade is over, its lessons remain. Some of those lessons involve the spectacular dysfunctionality of the Senate. What I want to focus on right now, however, is the incredible gap that has opened up between the parties. Today, Democrats and Republicans live in different universes, both intellectually and morally.

Ah, here we go - an appeal to morals. Why did I know - right in the second paragraph (and why did you bury the leade, Paul?)

Take the question of helping the unemployed in the middle of a deep slump. What Democrats believe is what textbook economics says: that when the economy is deeply depressed, extending unemployment benefits not only helps those in need, it also reduces unemployment. That’s because the economy’s problem right now is lack of sufficient demand, and cash-strapped unemployed workers are likely to spend their benefits. In fact, the Congressional Budget Office says that aid to the unemployed is one of the most effective forms of economic stimulus, as measured by jobs created per dollar of outlay.

But this makes an assumption Paul, and one that you and the rest of the Democrats have refused to face (to their credit, the Republicans haven't faced it either!): This sort of "bridge" or "pump priming" only works if there is underlying final demand that can come back.

But here's the problem - the so-called "stimluls" didn't do much in the US. Why not? It stimulated China!

The Senators have singled out a particular wind project in Texas for criticism. China's Shenyang Power Group, the U.S. Renewable Energy Group and a Texas company called Cielo Wind Power are involved in a joint venture to build a 648MW wind farm. The Senators says the project is on the verge of receiving $450 million in grants, despite the fact it uses Chinese-made turbines, and that the lion's share of jobs it creates are in China.

Yeah.

In point of fact, that 1603 "green" recovery act stuff has, thus far, diverted eight out of ten dollars outside of the United States.

This belies the real issue that underlies all of this.

Take Chicago. It used to be home to the Zenith picture tube plant in Melrose Park which, as you might surmise, made television picture tubes. It had been there for a long time.

But in 1998 it was announced that the plant would close, as the company was losing $300 million annually trying to compete with offshored production by people working in near-literal slave conditions with no environmental laws to add cost to the product. Thousands of good-paying local jobs disappeared.

I used to drive by that plant on a regular basis, the proud sign of American manufacturing throwing its illumination on I-294. My parents owned a Zenith television when I was growing up.

That's a microcosm of what's happened. We've offshored our production, by and large, to places like China. What has replaced these jobs are positions in finance, which is a parasitic enterprise - that is, it obtains the money that is "earned" not from producing things, but from siphoning off cash flow from everything it touches.

Such a shift is inherently destabilizing. We made up for it by running our credit cards to the moon, both figuratively and literally. We blew a bubble first in Internet stocks and then in housing, which allowed people to then "access" (the true word, "extract", is so ugly isn't it) the faux value that we claimed it. We, on balance, did so and spent it.

The error in Krugman's analysis is that he believes that all this "pump priming" will do the job and the economy will recover, allowing us to pay back what he avers is an effective loan.

My question to Paul and all those like him: How?

We can't support a financial system that consumes 1/4 of every dollar that goes into the economy, siphoning it off. The margins are not there to permit that. They never were, but refusing to attend to this, as Paul and his cohorts have done (and to be fair, the Republicans are no better in this regard!) is how we wound up with a debt bubble.

So what's the solution?

As much as you don't want to hear it there are only two answers:

Drive manufacturing back to the United States. There is only one way you can compete with someone making $2/day unless you're willing to make $2/day, and that is government interference. We have a constitutional mandate for such a thing - they're called tariffs. Yes, I know all about Smoot-Hawley. Guess what - trade imbalances are at their core behind a lot of depressions, and the founders were smart enough to leave us with the hammers to pound down those nails.
Accept a much lower standard of living for huge swaths of the American Population. Essentially, if you're not a rocket scientists (or his equivalent) you're going to pound nails for minimum wage - maybe.

Both of these outcomes require that the financial system's "grift" shrink dramatically. It cannot be otherwise. But #2 means the end of the social program "backstop" that we currently have, because it cannot be sustained.

We cannot spend $1.3 trillion more than we take in via taxes for these "support programs" indefinitely. Krugman thinks we can, but he's wrong. Iceland thought this, Greece thought this, Argentina thought this.

You know what happened in the former and latter, right? The middle nation in that list might meet the same fate. Their so-called "austerity measures", from my back-of-the-envelope calculation, won't work. It's nowhere near enough!

Now let's look at what did happen to Greece. Their 10 year bond offering went off at 6% - double what Germany is paying to borrow for the same amount of time.

What happens if our bond carrying costs double?

We carry, today, $8,026 billion (that's $8.026 trillion) in publicly held debt in the United States. Ignoring the $4.482 trillion in "intergovernmental holdings" (that's fancy speak for Social Security and Medicare "current issue" promises that we won't keep, as those "promises" back 20x that in claimed benefits for the next 75 years!) if we were financing the debt at our current 10 year rate we'd pay $289 billion a year.

Of course we don't do that - some of it is longer duration, some shorter. Last year it cost us about $180 billion in total, mostly because of the collapse in interest rates.

Now let's assume that we have a "Greecefire" here in the US and our Ten Year rate goes to 7%. Interest costs would go from $289 billion to $562 billion.

But that assumes we don't add to the debt, and we are. In fact, we added $1.4 trillion last year and will add $1.7 trillion this year. If we keep "pump priming" through the end of the decade (as the CBO says we will given their projections - and they are projecting GDP growth in the 4% range for the entire period!) we will go from the current $8.02 trillion to approximately $14 trillion in public debt by the end of the decade.

That figure, at 7%, would produce an interest cost of close to $1 trillion a year - or about half of all federal tax receipts.

So which is it Paul?

At some point we have to face the facts: We can't continue to spend more, as a nation or as individuals, than we make. We cannot make promises that are impossible to fund, instead putting it off with more borrowing. We must face the imbalances we have fostered in our economic system, along with the trade imbalances that we not only have fostered over the last 20 years but are feeding with so-called "stimulus" that instantaneously flows overseas instead of helping Americans.

There's plenty of blame to go around, but what is not helpful, and solves nothing, is ranting about how Jim Bunning's demand that these extensions in unemployment payments be offset with federal spending cuts somewhere else, or that they be taken from already-budgeted funds such as the TARP.

That, Mr. Krugman, was his objection. Not that the benefits were being extended, but rather that they were not paid for.

The liberals are always quick to pull out the national credit card. They've been doing so for the last 30 years. But this sort of spendthrift approach to everything that ails us has left us with a severely-imbalanced economic structure that no longer produces enough to carry its own weight.

The (credit) drunk needs a stint in detox Mr. Krugman, not another bottle of whiskey.

Captain, We Cannot Withstand Another Attack

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 09:18:00 -0500

So now we have Senator Dodd saying:

"I can't write regulations, this is way beyond the competency of Congress"

Really Mr. Dodd?

How about "Bankruptcy Reform"?

How about the CARD act, which as you can see from my Ticker yesterday, was instantaneously circumvented by the banks. Instead of "jacking interest rates" they simply put a CALL feature into their account disclosures, which now means you get raped by having the entire balance on your card due and payable literally on demand. (As an aside, how hard would it have been to say "no adverse actions" as a consequence of universal default, instead of what was actually done? Oh, and did banking lobbying interests recommend the language you did adopt?)

"The business community needs certainty on this issue," he said. "We ought to leave it to them to make the recommendations."

Really? Like the business community "recommended" OptionARMs, automated underwriting, blacklisting appraisers that didn't participate in outright fraud on property valuations, bankruptcy "reform", Credit Default Swaps, Synthetic CDOs and more?

Who's on the other side of the table? What other voice is there on input into this process?

None.

Now let's look at results. I would have no quarrel with a wildly business-friendly environment if it produced prosperity.

But it did not.

It instead produced asset-stripping, fraud, scams of various dimension, a huge housing and credit bubble and threatened the nation, if Hank Paulson is to be believed, not just with economic depression but literal martial law.

If I in concert with others took actions that threatened the destruction of our government by force, and thus gave rise to an argument that martial law would have to be declared, I would (justifiably) be held on charges of seditious conspiracy. Can someone explain why firms and individuals, acting between themselves in a fashion that leads them to effectively demand a $700 billion bailout lest the tanks roll, fails to meet this definition under the law?

We keep talking about how the government "saved us" from the depths of Hell - literally - with their "extraordinary measures." Whether it is Congress, The Administration or The Fed, all are credited with keeping the nation (and perhaps the world) from going over the cliff and straight down into the land of brimstone and sulfur.

But are we actually standing on terra firma, or are we playing Wile-E-Coyote dangling in the air?

Let's look at the facts.

We claim to have "decent" growth now, running about 3.5% (expected) for the full year of 2010. But that growth is false; Government is borrowing and spending an additional 9% of GDP beyond what it was before the disaster began, it has been doing so now for two years, and there is no inclination that it is going to slow down or stop. Indeed, there is every reason to believe that the government can't stop, lest the economy instantly implode, as final, true demand simply has not recovered. It is, in fact, at depression levels - right now.
We supposedly prevented a monstrous cross-default credit default swap explosion. Or did we? Did we get rid of the credit-default swaps? Have we proved that everyone currently "short" them has the ability to pay? Can I reasonably expect that if there is a default in some bond issue that the counterparty is good for it? Nope - none of the above. In fact we have every reason to believe that the threat of a cross-default explosion is larger today than it was in September of 2008.
The centroid of this mess is claimed to be housing. Has housing recovered? No - yesterday's existing home sales figures strongly suggest that the recent "tax incentives" have in fact worn off - they no longer do anything to spur sales! The scary possibility, of course, is that they are effective, which means when they expire later this year sales will utterly collapse. We'll find out which is the case here in a few months.
Do we have reasonable transparency in bank balance sheets? Nope. Not only do we know that Wells and Citi have over $1 trillion in off-balance sheet exposures each (and we have absolutely no clue how much either of those exposures is worth "at the market" today) we also know that the Federal Home Loan Bank of Seattle, the poster child for mark-to-model which claimed only about $10 billion of expected "loss" on what was a mark-to-market loss of $300 billion is now suing for the entire $300 billion. In other words, the "model" folks were wrong, and those such as myself who insisted that we had to mark to the market and that market prices reflected actual loss levels were (and are) right. If that "ten times worse than we claimed" projection for embedded losses is anything close to typical the entire banking system is still insolvent.
The states are going broke. Fast. California is "firing" 15,000 San Francisco employees, then "re-hiring" some of them but holding down hours. The Illinois and California university systems are imploding, and major protests are occurring (apparently the students involved failed their middle-school math classes.) The states have made pension promises they are bound by state constitution (in many cases) to keep, but which mathematically can't be kept, and some of them result in payouts of $200,000 or more annually with retirement permitted at 55 (for the math-impaired this results in a likely pension of more than $6 million smackers!) New York and New Jersey have critical state funding shortages. Sales tax receipts remain in the toilet, despite the repeated claims of "a turnaround in economic activity." Public-sector unions, including police, firefighters and teachers have responded to calls for them to take the same sort of 20% or more cuts in pay and benefits that have been widespread throughout the private sector with threats. We have allowed public sector employees to define for themselves growth in their costs that exceed growth rates in the productive economy. Mathematically, this cannot continue.
Treasury yesterday claimed "There is no government guarantee for big financial firms." This is a lie. By definition any bank that can come to the government and say "help us or the economy will suffer critical damage" has such a guarantee, whether Treasury admits it or not.

Now consider this: There is neither the capital or the political will to go through another bailout cycle. Not now, not any time in the foreseeable future.

IF a sovereign nation starts a chain-reaction default (e.g. Greece, Spain, etc), IF there is a massive fraud discovered at one of the big banks, IF there is a speculative attack on a currency, any of a thousand IFs.

We won't be able to stop it.

Not The Fed, not The Government, not anyone.

We have been given the ability - a gift really - to pull the fuse on this mess. To lock up the nuclear financial weapons away from the kids. To let the adults in the room.

So far, we've not only done none of the above, we've gone further to concentrate and increase systemic risk.

We cannot withstand another attack.

Everyone wants to talk about health care. Sorry folks, that's a misdirection. A scam. It is simply a way to try to get more tax revenue - right now - to stave off a possible federal funding crisis. Treasury knows it, Obama knows it, and Congress knows it.

They won't tell you, but they know the truth.

We cannot withstand another attack.

We must break up the large financial institutions that caused this mess. What sort of act is more anti-competitive than going to the government and threatening it with economic armageddon if it does not hand you billions of taxpayer dollars? Whether it's a loan or a handout makes no difference - the very issuance of such a threat is a declaration of trust behavior banned under The Sherman Act, among others. We need no new laws to deal with this situation - we simply can and must enforce the existing ones.

We cannot withstand another attack.

Stiglitz, in a remarkable display of truth, said today that The Federal Reserve System is corrupt. He's right, of course. What other explanation is there for an institution that literally sat back and watched more than $10 trillion in fraudulent credit creation take place - all so a bunch of banksters could make billion-dollar bonuses? This must change - here and now.

We cannot withstand another attack.

But we're gonna suffer one, and soon, if we don't pull the fuse.

The Credit Default Swap monster has to be caged. I know I sound like a broken record, but it has to happen. Now. Today. I don't give a damn if the banks like it or not. I don't care if bankrupts all of them. It has to happen now.

The off-balance-sheet crap has to be exposed and valued, along with everything else, at the market. Yes, I know it will cause major problems for the banks. I don't care. It has to be happen now.

We have to get control of federal spending. We cannot spend $1.3 trillion more a year than the government takes in via taxes. We just can't. We're getting away with it right now because everyone is scared that Greece is about to blow the Euro Zone to pieces. But once that either happens or the fear recedes, the speculators will point their weapons of financial destruction here. We have either fixed the problem before then, or we're next.

And finally, we must know what The Fed is holding, what they've bought, what they've monetized, who got paid off and what sort of trash is hidden in the black hole known as their balance sheet. This means full audits - now and evermore in the future. No exceptions.

If you remember back when Paulson's "bazooka" was first discussed I said that the market calls all bets.

It did.

Within days.

We're there again folks, about to witness the market calling our leaders' bet again, and we are enjoying a respite only because there are other hookers in the room of nations with a worse case of crotch rot than we have.

But that's not a sign of strength - it is a sign of danger, for our own particular financial STD has not been cured.

We're running out of time to take the penicillin.

Bove: You Can't Fix Stupid (Him)

nospam@example.com (Karl Denninger) — Wed, 03 Mar 2010 17:39:00 -0500

In a nice rant intended to be an attack on AG Cuomo (who would like a "better job", natch) Dickie once again leads me to ask: "Did you pay extra at God's brain handout desk for the vacuum between your ears?"

Dick, let me ask a few "pertinent" questions....

If the "primary business" in a given state was selling crack, would you propose that doing so should be ok because, well, it's the primary business?

What if it was ripping off little old ladies?

What if it was selling swampland as "pristine real estate"?

What if it was marketing drugs that were laced with cyanide?

Or faulty cars (exploding Pintos anyone?)

If the company doing any of those things was the dominant employer in a given state, then the AG should give them a pass, right?

Oh I know, that's not what you meant.

It is, however, what you said.

If you want to go after Cuomo's record with regard to HUD, that's a valid area to explore, and Bove started there. But Fannie and Freddie's mess is not, in the main, due to subprime mortgages, nor did HUD have anything to do with OptionARMs and all the other tricky crap. Indeed the primary problem is the garbage securitizations - most of which had nothing to do with the GSEs, along with synthetics and other dubious piles of dog refuse dreamed up by Wall Street.

But arguing that an Attorney General, who's charge is to enforce the law no matter who is committing the crimes - that is, bring suits and criminal charges against people who do bad things as the laws of a given state proscribes, should exempt certain big and powerful corporations and/or individuals from those laws because they employ lots of people and/or bring in lots of tax revenue is, in effect, to demand that a State's AG partner with the Mafia!

Some of us - hopefully the dear readers of The Ticker - are too smart for that sort of rank endorsement of outrageous (and perhaps criminal) conduct and instead believe (and demand) that the correct thing for Wall Street to do is behave both ethically and lawfully.

If they do that - behave ethically and lawfully - they have nothing to fear from Mr. Cuomo - or anyone else.

Whadda 'Ya Mean It's Not Over?

nospam@example.com (Karl Denninger) — Wed, 03 Mar 2010 08:35:00 -0500

See, I told you so....

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

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

As the report says:

The crisis of 2008 was predictable. Unless we go far beyond current legislative proposals the next crisis is inevitable.

146 pages of rather dry reading, but worth it.

I have only one argument with the paper's base premise, and that lies here:

This cycle will not run forever. One day soon, we’ll have the boom and bust phases, but when we try the usual bailouts, they won’t work. The destructive power of the down-cycle will overwhelm the restorative ability of the government, just like it did in 1929-31, when both the financial shock and the government capacity to respond were on a much smaller scale. The result, presumably, will be something that looks and feels very much like a Second Great Depression.

The error is in thinking that the "restorative power" of government has worked this time.

It has not. Instead of being a restorative power, it has instead been simple hiding of the facts - or, if you prefer a more-simple word for it, lies.

We have hidden, rather than fixing, balance-sheet deterioration. We are permitting insolvent financial institutions to continue to operate in the belief that they can "earn their way out of the hole" over time, effectively imposing a monstrous (more than $1 trillion annually, or 7% of GDP) tax on the economy. Then we have imposed another 9% tax on the economy in the form of government borrowing to paper over the lack of final demand.

Taken together, this is a 16%-of-GDP tax addition to the tax burden already imposed, and there is no evidence that it will abate.

The report talks of raising capital requirements to somewhere between 15-25% of assets for financial institutions. But that's a chimera too - not all assets are the same. As I wrote in my piece of November 13th of last year, there is a much simpler way to compute capital requirements that is not subject to regulatory arbitrage or games: do not permit institutions to make any loan that is unsecured unless the unsecured portion of that loan is backed, dollar for dollar, by a dollar of actual capital.

Regulatory arbitrage is better thought of as bribery. The solution to eliminating bribery is to eliminate all the places where one can stuff a pile of cow dung under the carpet. If the decaying fish is on the kitchen table for all to see, and the stench cannot be concealed, then it becomes extremely difficult to buy people off.

This means an end to all credit derivatives that are not exchange-traded (not "registered"), so that nightly mark-to-market accounting is enforced by a real party at interest - the exchange which has to make good on them. It means an end to "naked shorting" in all of its forms. It means an end to the creation of synthetic instruments unless the person you sell them to receives a prospectus disclosing why and how that derivative came into existence - and at who's behest it happened.

At the core of this problem, along with essentially every banking crisis in the past, is a refusal to speak publicly about the truth of financial institutions: they provide no actual constructive contribution to GDP.

That is, they produce nothing.

Financial intermediation - when it works properly - is by definition a function of matching buyers and sellers of money. That is, by definition it is a parasitic function that draws its "income" off the transactional stream of commerce.

But a parasite is only "successful" if it is able to remain healthy without significantly impairing its host. The most-obvious violation of this principle, of course, is a parasite that kills its host - that organism has failed in its essential purpose if it fails to reproduce before the host dies.

In terms of economic systems failure is more graduated. Certainly a financial system that kills the underlying economy has failed in its essential purpose. But one that imposes regressive and ridiculous effective tax rates - even when not called a tax - has taken the intermediation function and turned it into a death-spiral of vampirism.

Such is the system we have today. Banks are considered an economic force in their own right - not because they add something to GDP (they're incapable of doing so) but because they are able to control the rise, fall, birth and death of others. The financial intermediation function has become an end in of itself, instead of being a necessary piece of "lubrication" for commerce to proceed. This in turn has led to ridiculous and even outrageous acts, such as the SEC Complaint alleges occurred in Jefferson County, Alabama:

Charles LeCroy and Douglas MacFaddin, the two former managing directors, privately agreed with certain County commissioners to pay more than $8.2 million in 2002 and 20)3 to close friends of the commissioners who either owned or worked at local broker-dealers.

3. Although labeled as payments for work on the transactions, their true purpose was to ensure that County officials selected the broker-dealer, J.P. Morgan Securities Inc., as County bond underwriter, and the bank, JPMorgan Chase Bank, N.A., as County swap provider.

The common word for what is alleged, my friends, is bribe.

Yet when these sorts of things are uncovered the government, in an attempt to "not upset the apple cart" of the vampiric Wall Street mechanism, sues - instead of prosecuting! As with most of these suits this one will likely to be settled with a fine, where if you or I engaged in the same sort of corrupt practice alleged here we'd be sitting behind a set of bars for a decade or more.

The solution to these problems is not found in incrementalism. Rather, it is found in formal and legal recognition of the essential purpose of financial entities - and enforcing the boundaries of same.

In short, financial institutions are intermediaries. Their purpose and function thus inherently must come with fiduciary duty, since without that duty they have no purpose in the economy at all.

Breaches of that duty must be dealt with through harsh sanction, as the essence of their purpose and action cannot inherently come from a desire to profit, but rather their purpose is to help others profit through productive enterprise.

Viewed in this context there is nothing difficult about regulation of these entities.

They must be forced to hold one dollar of capital against each dollar of unsecured lending that is outstanding, no matter to who or on what terms.

They must be held to a fiduciary duty of care with all of their clients, irrespective of which "side" of a transaction they, or their client, happens to be on.

This inherently bars all proprietary trading activities by these institutions since doing so is an inherent and inseparable violation of that fiduciary responsibility toward the persons whom they serve. It cannot be otherwise.

Incidents of bribery, blackmail and dishonesty - irrespective of the form it comes in - must be dealt with both quickly and severely, since all such acts inherently damage the very persons who they have that fiduciary duty toward.

If we had taken this approach to financial entities there would have been no ENRON, no LTCM, no Internet Bubble, no Housing Bubble, no Greece, no AIG, no Lehman and no Bear Stearns Hedge Funds.

All of the financial crises since the 1980s - each and every one of them - would not have happened.

The answers to the problems are simple, if we choose to open our eyes and consider the only actual function that financial entities perform in our economic picture.

If you're wondering why employment is not rebounding, why The Federal Reserve's own data shows collapsing government tax revenues along with final demand in the toilet while spending is skyrocketing, you need only look at the financial system's vampiric behavior and our government's refusal to deal with those acts as they should for the answer.

For as long as we fail in this regard we will condemn ourselves to an ever-increasing "duty" or "tax" that is diverted by these institutions. This is an inherently unstable configuration and, as the financial system's effective tax rate is now reaching toward 40% of the economy as a whole (including the inputed taxes from bailouts and handouts) we are rapidly moving toward the "over-center" point (50%) where the cycle becomes self-reinforcing - and collapse becomes inevitable.

The time to do the right thing has basically run out.

Speculative Premium - And Why The Markets Will CRASH

nospam@example.com (Karl Denninger) — Mon, 01 Mar 2010 11:34:00 -0500

Yes, I said CRASH, and I meant it.

Why?

"Events" like this:

SINGAPORE/CAIRO, March 1 (Reuters) - Copper is likely to
climb when trading starts on Monday, lifted by uncertainty over
supply after the world's top copper producer Chile was pounded
by a massive earthquake, analysts said over the weekend.

The front-month contract opened up more than 8%.

This, despite the fact that the earthquake was hundreds of miles away from the mines in Chile and there was zero damage to them. Some were offline for a few hours due to power failures, but none suffered any physical or structural damage, nor did their export points and the transportation network between the two.

So why did price spike more than 8% even though all this was known by the market before it re-opened for trading?

No part of the markets are trading on fundamental values, nor on forward business expectations. They are instead trading as "hot money" repositories where speculators rotate in and out of various instruments literally on a minute-by-minute basis.

This is how crashes happen.

When there is no fundamental value underlying a market there is no floor on price. Price then becomes one thing and one thing only - the number at which you can find another sucker to take your position from you.

This is how tulip bulbs went nuts in Holland, it is how houses went nuts in California in 2005, it is how tech stocks went nuts in 1999 and it is how oil went nuts in 2008.

But now literally everything has gone this way.

Take European national debt. We now know that Italy, for example, was cooking their books as early as 1995. This means that bond buyers overpaid for their bonds and took less coupon than they should have. This should have resulted in an immediate destruction in the value of those bonds when discovered, but it did not.

Why?

Because there was still a bigger fool.

Tech stocks were the same thing in 1999. These "companies" claimed the global GDP some 100 times over between the IPO-issuers in 1998 and 1999. This, of course, is impossible. Yet people kept buying even though mathematically 99% of them had to lose all their money. Ultimately, they did exactly that.

Oil went to $150 in 2008 even though demand was cratering. It then collapsed to under $40. It is now double that, even though we have a record supply on hand, to the point that tankers are sitting around full of crude with nowhere to unload it to, and nobody to buy at the price paid. Yet the price continues to go higher.

These conditions, historically, always produce crashes. Each and every time. Go ahead and look back through history with a dispassionate eye. Find me a market that displayed a complete disconnect with fundamentals such as this and did not crash.

You can't.

The issue for investors, of course, is that it is almost impossible to determine who will finally stand up and blow a whistle that others listen to. These manias go on longer than anyone would think possible. Always. I was stunned in 1999 as the Nasdaq doubled. Likewise in 2009 I was stunned as prices went straight up on companies that based on any dispassionate analysis are worth zero - for example, every large bank with undisclosed off-balance-sheet exposures (that would be most of them.)

The overnight move in Copper is yet another confirmation point. Big banks leasing oil tankers to fill up and moor somewhere "waiting for price to go up" was the first indication that this mentality had taken hold last year. Stocks were the next, of course, and now we have it in copper.

That the "animal idiocy" came just months after the 2008 crash tells me that we've learned exactly nothing. That the idiots in places like CNBS, including most especially people like Kudlow and LIESman, who have seen enough dances to both know and be able to identify this pattern, refuse to discuss what's going on borders on criminal journalistic misconduct.

If we had indications in the real economy - that is, other than government borrow-and-spend - that we were turning the corner, I'd be a bit more sanguine. Unfortunately no such indication has appeared, despite literally six months of claims from the media that it's "just around the corner."

No it's not folks. What's around the corner is another collapse, worse than the 2008 one, because the bad debt has been stinking up the joint even more as it decays into a putrid mess.

A dead fish doesn't get more palatable the longer you leave it out on the kitchen counter. We've learned nothing collectively or in the government regulatory apparatus from the last three years - indeed, government has become drunk on the premise that it can borrow and spend over $1.5 trillion annually to present a false veneer of prosperity and economic improvement.

But borrowing money doesn't make your economy more prosperous. It indeed makes it less so, because you not only have to pay that money back some day, but for the duration of the time you have it outstanding you must also pay interest.

When I see a nation rocked by a massive earthquake and one of its major exports spikes upward by 8% in price when it is known to the market that disruption to that nation's production of that commodity from the event was zero, that's the bell being rung to tell you to be damn careful if you think "happy days are here again" - right here, right now.

I've Seen This Movie Before (Bailouts & Greece)

nospam@example.com (Karl Denninger) — Sun, 28 Feb 2010 23:34:00 -0500

I seem to remember once upon a time when Charlie Gasbag-a-rino would come on CNBS virtually on a daily basis, with the DOW down 200, and announce that Ambac, MBIA or both were "about to be bailed out" - attributed to "sources."

Only one problem with this, you see - it never happened.

Then there were the claims that Warren Buffett was going to buy, well, the world. That never happened either, but it was always good for a pump here and there in the markets - only when they were in danger of really tanking, of course.

And now we're seeing it again, this time with Greece.

Over the weekend we have seen multiple competing reports of some sort of "deal", starting right near the close of the US market on Friday. It was undoubtedly responsible for the near-meteoric rise of the futures into the lock-up - nobody would want to hold short into the weekend with such a thing happening, right?

Well now Angela Merkel has said - once again:

"there is absolutely no question of it".

"We have a (European) treaty under which there is no possibility of paying to bail out states in difficulty," Merkel told ARD public television.

Right.

Maybe.

But let's look at the facts here.

Is this really about bailouts?

Or is this just more criminal manipulation of markets, with certain privileged players placing bets in the marketplace, then starting rumors?

After all, the blatantly-obvious front-running of the famous August 2007 Discount Rate cut wasn't investigated - or prosecuted, even though a three-year old could look at the chart for the day before and see that obviously someone (or a group of someones) knew in advance that Bernanke was about to do that - and they traded on it.

Then there were the AMBAC/MBIA rumors, the incessant Buffett rumors, the shorting ban (which was also traded on in front of the announcement by an afternoon) and more.

Not one of these has led to a formal investigation, yet all trades are trivially traceable. If the government gave a good damn about prosecuting this sort of information leak and front-running, all of which is illegal by the way, the records do exist. All they have to do is look.

This sort of corrosive and pervasive scam destroys confidence in our capital markets. I am convinced that a huge part of the reason that we had the collapse we did in 2008 and early 2009 - the reason it was so violent and essentially impossible to control - was that confidence in the markets had been destroyed by months of outrageously unlawful conduct in this regard.

When the "triggering thing" happened - Lehman - it just all came apart at once, since nobody trusted anything any more.

What makes anyone believe this is over?

The scam machine is still running. The rumor-mongers are still plying their wares, getting in front of the alleged news (even though it is repeatedly faked) and stealing investors money - time and time again.

We have learned nothing. Our law enforcement agencies and politicians have not only learned nothing, they have put in place the very same instabilities that led to the collapse last time.

It will happen again, and probably sooner than anyone expects.

Our SEC is a joke and the international regulators are even worse. We have no desire among those people to investigate the outrageous actions of these scam-meisters and lock them up. We should, but we don't.

Your memory should be good enough to remember what happened the last time. It should also be good enough to remember why it happened the last time.

We've changed nothing.

Are you insane enough to believe that the outcome - having done the same thing - will in fact be different?

These Are Our Friends, Trading Partners AND BANKERS?

nospam@example.com (Karl Denninger) — Thu, 25 Feb 2010 20:49:26 -0500

What the hell is wrong with the leaders of this nation?

CBS 60 Minutes has a video you must watch.

Watch as a Department of Defense employee is caught on tape selling military secrets to a Chinese spy. 60 Minutes' Scott Pelley reports, Sunday, Feb. 28, 7 p.m. ET/PT. (click above)

The tape shows a Chinese spy obtaining the list of weapons that we intend to sell to Taiwan. This, of course is rather topical, seeing that this little dust-up just happened - remember?

BEIJING (Reuters) - Senior Chinese military officers have proposed that their country boost defense spending, adjust PLA deployments, and possibly sell some U.S. bonds to punish Washington for its latest round of arms sales to Taiwan.

WHY IS IT THAT WE, THE PEOPLE OF THIS NATION, PUT UP WITH THIS CRAP?

I'm not willing to pay down one damn nickel of the so-called "debt" that China holds. Not one nickel.

They can blow me.

All of them.

Espionage with your "best friends" and "trading partners" eh? With those that you claim to have an "important relationship" with?

I think not.

I think it's war, and it's time we recognize it for what it is.

In fact, I'm so sure it's war that I think we, the people of this country, should demand that our Treasury Department tell the Chinese to stick their bonds up their ass. All of them, including those they're buying through British banks.

And if Treasury won't, and President Obama won't, that's fine.

We should refuse to buy anything that comes from China.

Yes, I know that's hard these days. You know what? I don't care.

These people are not our friends. They are murderous thugs who are stealing our military secrets - so they can use that information to point weapons at us. Terrible weapons. Nuclear weapons.

And we're giving them the money and the power to do it every time we go to WalMart and buy more of their Chinese-made crap.

I say f^#k no to that.

You should say it too.

We should all demand that our government say no, or we'll say no for them to Chinese products and we'll say no TO them - the politicians directly - in November.

It's that simple.

When you owe the bank $10,000 you have a problem. We owe them $2 trillion dollars. As a consequence the problem is theirs and the solution ours - tear those bonds up, declare 'em worthless with the stroke of a pen.

Do it Washington - or we boycott Chinese products and do it for you.

Clap-Clap (Weil and The Mark-To-Market Scam)

nospam@example.com (Karl Denninger) — Thu, 25 Feb 2010 08:23:00 -0500

Heh, if I bag on people, I have to provide the cheer when its appropriate too. And this time, it is:

About a year ago, the government-chartered lender blamed accounting rules after it wrote down its portfolio of mortgage- backed securities by $304.2 million to reflect how much their fair-market values had fallen. While those declines counted against its earnings and regulatory capital, the bank said they were “well beyond any expected economic loss.”

The bank’s executives said they expected to lose a mere $12 million of principal over the life of the securities. That estimate proved far too hopeful, though.

The bank, one of 12 regional Federal Home Loan Banks that supply low-cost loans to about 8,000 member banks and finance companies, now says it expects about $311.2 million of credit losses on its portfolio.

Remember this folks?

The banks - including the FHLB system - all said that "mark to market" was unfair. If you remember the biggest fraud ever foisted on the investing public was rammed through by Congress literally threatening FASB in open hearings. They got their "mark to model" and we all heard that the world was good, milk and honey was back and the banks were not going to take these huge losses since they'd simply wait for the market to improve and the loans would all be ok.

Except they weren't, and the "estimated" original $300 million loss (before "mark to fantasy" was given back to them) turned out not to be the fantasy $12 million "model" loss trotted out before Congress, but in fact is now $311 million.

Heh wait - that's kinda close to $302, no? It's a hell of a lot closer to $302 than it is to 12!

At the time I wrote a proposal on how we could temporarily use a MTM suspension to clear the market - by putting a date-certain on the end of all games, all Level 3 BS, and all off-balance sheet exposures. That, of course isn't what Congress forced FASB to do, basically at gunpoint.

But now the facts are in. As I wrote about on January 28th, FHLB Seattle is now going after the bundlers of the trash. And their claim is not just for a couple hundred million. Oh no - they're after $2 billion smackers.

Does this count as the jury being in on actual valuations?

Mr. Weil thinks so and so do I. Then again I called it BS from the start when it was unpopular to do so.

Jonathan's final word says it as well as I could:

Those explanations aside, what happened here is that a few members of Congress bum-rushed the FASB into action based on a premise that was false, in a misguided effort to boost public confidence in the financial system through smoke and mirrors. It’s an open question if the board’s standard-setting process can regain its credibility someday. Undoing this disaster of a rule change would be a good start.

You forgot "jail all the crooks", but I'll forgive you for that.

Balance sheet fraud is how we got ENRON. We learned exactly nothing from it, and we're still doing it.

Congress may have had Geithner and everyone else in the "industry" telling them that they "had to do this to save the world", but in fact it hasn't save anything. The losses are still there and in fact have gotten worse.

We've done nothing other than making legal accounting lies. The impairment and thus the actual economic loss still exists, and while we may have pushed it off another year that actually makes it worse, because these non-accruing loans gather more and more hair on them the longer they sit around without being either foreclosed, put back, or otherwise disposed of.

This part of The Bezzle is one of the worst examples in this entire sordid mess and if Congress won't grow a pair then FASB needs to - right now.

PS: If they don't, cash flow will eventually burn these guys. You can play with a balance sheet all you want but the electric company only accepts actual money in exchange for keeping your lights on.

Tickerguy On Max Kaiser

nospam@example.com (Karl Denninger) — Wed, 24 Feb 2010 12:08:51 -0500

About 14 minutes in...

FICO Scores Becoming Irrelevant?

nospam@example.com (Karl Denninger) — Wed, 24 Feb 2010 09:37:16 -0500

The press release from Fair Isaac yesterday, noted on the forum by Geckogm, caught my eye for a number of reasons - not the least is that essentially the first tickers foretold what they reported - three years ago.

Fair Isaac said:

MINNEAPOLIS--(BUSINESS WIRE)--FICO (NYSE:FICO), the leading provider of analytics and decision management technology, today announced new and troubling findings uncovered in the latest analysis offered by its subscription service for businesses, FICO® Score Trends. Reversing a long historic trend, mortgage default risk for consumers with high FICO® scores now exceeds their credit card default risk, even though most credit cards are unsecured credit and mortgages are secured by real estate. The company observed a parallel rise in mortgage delinquencies for higher-scoring U.S. consumers.

....

“We’re identifying lending industry situations in FICO Score Trends that to our knowledge have never been seen before,” said Dr. Mark Greene, CEO of FICO. “Economic instability is creating unknown risk in lenders’ credit portfolios as well as counter-intuitive trends in consumer behavior.

Baloney.

The only thing that's unknown is your lack of intelligence, "Doctor" Mark Greene.

I said on April 1st of 2007:

Let's say you have a $750,000 house. You took a first mortgage as a "2/1 10%" ARM, which is a common ALT-A product. Its cheap because the interest rate is only locked for two years, then it floats at LIBOR (a commonly used interest rate benchmark) plus some percentage. You then took an "option interest" loan for the rest (down payment, what's that?) or even better, you borrowed the downstroke somewhere, then paid it back using a "silent second" - a Home Equity line (HELOC) that had an "option interest" feature.

Well, now the chickens are coming home. Your house has actually depreciated in value by 10% because, well, nobody's buying right now. So you have a $750,000 house with a $750,000 mortgage but the house is only worth $675,000! What's worse is that the interest rate is about to reset 2% up from your "teaser rate", and you know you can't make the payments three months from now.

So you shop for a $500,000 house (remember, its a down market!) You qual for that mortgage (your FICO score is still quite good, as you haven't blown a payment yet) on the basis of selling the OTHER house. You get the loan on THAT house, but its an ALT-A product too; you simply lie about your income, and since its a no-DOC loan and your FICO is in the 650 range, it goes right through.

You move in, then default on the original $750,000 loan!

This is happening all over California, and the bank is left holding the bag!

Note that NONE of this is happening in the Subprime space - its all in ALT-A!

And virtually ALL of the lenders are exposed to the ALT-A mess.

See, I told you so - three years ago - that FICO scores would cease to be useful in predicting mortgage risk.

Mortgage companies have got to stop relying on automated models. Underwriting needs to be manual, with a person reviewing a file and examining the evidence. Capacity, Collateral, Character, Conditions and Capital.

Capital and collateral are interlinked. No or low down payments void those two considerations. These loans in the real estate world are unsound - period.

Capacity cannot be computed without hard ratios and has nothing do with a FICO score. You can have a very high FICO score and also have a very high debt-to-income ratio - so long as you're paying today.

FICO scores shouldn't be used in mortgage lending - at all. They tell you nothing that an examination of a borrower's credit file (manually) will not, and when used for mortgage lending they are dangerously misleading. I have consistently argued that exactly what Fair Isaac now admits to, three years later, would happen, and laid out exactly why in dozens of articles over the last three years.

It is time to banish the FICO score from mortgage underwriting and return to safe, sound, manual file inspection and decision-making with actual ratios that make sense.

Once again, 20% down payments in cash, 28% "front end" (PITI) and 36% "back end" (DTI) ratios should be the absolute floor for mortgage lending.

Yes, I know this would exclude many from being able to get a mortgage. That's not a bad thing, it's a good thing. It would keep people from buying homes that cannot actually keep and maintain them, and in doing so it would both help to prevent bubbles from forming in real estate it would prevent people from being dispossessed of their homes after being "helped" into transactions they cannot afford. Renters as opposed to owners are more-able to move where the jobs are, allowing them to be more flexible when the economy changes, following job opportunities instead of being forced to remain in an underwater mortgage with deteriorating job prospects.

Home ownership is appropriate for a significant segment of the population but driving home ownership without being able to reasonably guarantee that the 5Cs are complied with - which cannot be done via automated underwriting - guarantees that the only "winners" from such an "expansionary" policy for home ownership are the Banksters and Realtors while the general population has its wealth stripped.

This Is How It Begins (Wanton Violence)

nospam@example.com (Karl Denninger) — Thu, 18 Feb 2010 13:23:00 -0500

This is not the sort of thing you want to report on.

But I need to, because what looked like an accident originally - a horrible accident, with a plane on approach that had some sort of mechanical problem - now looks to be something else.

AUSTIN, TX (myFOXaustin) - A small aircraft plane has crashed into a 7-story office building in North Austin near Mopac and 183. The plane crashed into the Echelon building around 10 a.m. Thursday morning. Police have blocked off access roads around the building.

....

According to Corp. Scott Perry with APD several federal offices were located inside the building that was struck by the plane. Officials with NTSB say that IRS offices were some of the federal offices.

CNBS is reporting that there is "no indication that this was an act of terrorism or otherwise intentional." Oh really? Then how come CNBC is claiming on-air that the man involved set fire to his own house first? Oh, and Fox News just stated that the name of the pilot was.... Mr. Joe Stack.

Uh.... what's this?

I know I’m hardly the first one to decide I have had all I can stand. It has always been a myth that people have stopped dying for their freedom in this country, and it isn’t limited to the blacks, and poor immigrants. I know there have been countless before me and there are sure to be as many after. But I also know that by not adding my body to the count, I insure nothing will change. I choose to not keep looking over my shoulder at “big brother” while he strips my carcass, I choose not to ignore what is going on all around me, I choose not to pretend that business as usual won’t continue; I have just had enough.

I can only hope that the numbers quickly get too big to be white washed and ignored that the American zombies wake up and revolt; it will take nothing less. I would only hope that by striking a nerve that stimulates the inevitable double standard, knee-jerk government reaction that results in more stupid draconian restrictions people wake up and begin to see the pompous political thugs and their mindless minions for what they are. Sadly, though I spent my entire life trying to believe it wasn’t so, but violence not only is the answer, it is the only answer. The cruel joke is that the really big chunks of shit at the top have known this all along and have been laughing, at and using this awareness against, fools like me all along.

I saw it written once that the definition of insanity is repeating the same process over and over and expecting the outcome to suddenly be different. I am finally ready to stop this insanity. Well, Mr. Big Brother IRS man, let’s try something different; take my pound of flesh and sleep well.

Eek. That's a homicide note folks, as distinct from a suicide note in that he has declared that the acts to follow are intended to kill others.

I have archived the entire screed, as I fully expect it to "disappear" very soon. If it does, I'll fix the link with one to my archived copy.

Oh, the domain registration?

Registrant:
Embedded Art
925 E Hwy 80
287
San Marcos, TX 78666
US

Domain name: EMBEDDEDART.COM

Administrative Contact:
    Stack, Joe dns.5.sgmail@dfgh.net
    925 E Hwy 80
    287
    San Marcos, TX 78666
    US
    1.3215649879
Technical Contact:
    Stack, Joe dns.5.sgmail@dfgh.net
    925 E Hwy 80
    287
    San Marcos, TX 78666
    US
    1.3215649879

Registrar of Record: TUCOWS, INC.
Record last updated on 16-Sep-2006.
Record expires on 05-Jun-2010.
Record created on 05-Jun-2003.

Where is San Marcos?

Just south - by about 20 miles - of Austin.

Any questions?

Stop lying you media whores. It took me 30 seconds to uncover this - this is a raw claim of an intentional act published on the Internet - an act of a desperate man taken with the claimed intent of provoking a reaction and ultimately armed violence.

Let me make myself clear: this sort of "political statement" is exactly what this nation does not need.

I have repeatedly warned about the probable response if the population decides that the government is a felon instead of the cops. Among some of the points I have made:

Should the people come to the conclusion that The Government is in fact a felon - should there be no enforcement at the state level, no real move to "take back" authority vested in The Constitution, returning it to the states and to rein in the crooks, subjecting them to the just desserts for their crimes, there is a very real risk that The People will decide that there is only one way to obtain justice: through the actions of their own hand.

Lest you think this is an unrealistic view, I direct you to Mexico, where the police have become so corrupt that the people are now catching burglars and torturing them on their own. Vigilante justice is swift, certain, and brutal.

But it is the logical and expected outcome when the people reach the breaking point. Those who believe it "can't happen here" are deluded - it both can and will if our government does not stop condoning and in fact conspiring with the crooks that have robbed the people of this nation.

And by the way, this is not just some "crackpot Internet blogger" saying that the nation has been looted. How about William Black, a recognized national expert, one of the people who prosecuted the fraud in the S&L Crisis, and who has said, in part:

WILLIAM BLACK: In the savings and loan crisis, where the national commission finds that the typical large failure fraud was invariably present, we had over 1,000 convictions of senior insiders, what the FBI referred to as priority cases. At this stage among the subprime lending specialists, we have zero convictions. We have zero indictments.

PAUL SOLMAN: So, what would you do?

WILLIAM BLACK: I would prosecute the felons.

So, in September 2004, the FBI began publicly warning that there was -- quote, unquote -- "epidemic" of mortgage fraud, and it predicted that it would produce an economic crisis, if it were not dealt with. The FBI has also said that 80 percent of the mortgage fraud losses occur when lender personnel are involved. So, Fitch looks at a small sample of these loans, finally, in November 2007.

PAUL SOLMAN: Fitch is one of the ratings agencies?

WILLIAM BLACK: Yes. It's the smallest of the big three.

What did they find? They said, the results were disconcerting, in that there was the appearance of fraud in nearly every file we examined. And they said that normal underwriting would have detected all of those frauds.

History tells us what the response is to "Let them eat cake", and I do not wish to witness a repeat of that ugly episode in the United States! Our Constitution and system of laws is supposed to make that impossible, but as we have seen, it doesn't seem to have worked all that well over the last two decades, has it?

STOP THE LOOTING AND START PROSECUTING!

Update: The FBI is apparently (from other online reports) trying to have copies of the original "manifesto" taken down. The Smoking Gun has the original up, so I have linked it there for now. We'll see how they deal with the inevitable "request", if any, assuming they actually get one and this isn't just Facebook and a few other sites "deciding" they don't want to be involved in a "controversy" (as opposed to a legitimate FBI demand.)

Media Idiocy: "Consumers Spend at 2009 Levels"

nospam@example.com (Karl Denninger) — Thu, 18 Feb 2010 11:04:00 -0500

Pay particular attention to this snippet:

WASHINGTON, Feb 18 (Reuters) - American consumers say they reduced their spending in January to levels similar to early 2009, when the U.S. economy was still in recession, according to a Gallup poll released on Thursday.

The findings, which contradict U.S. data suggesting spending strength in January, showed consumers in all income brackets and geographic regions spending less in January vs. December in stores, restaurants, gas stations and online.

Reuters then goes on to claim:

The economy has grown for two straight quarters after the worst downturn since the Great Depression. Financial markets are now watching closely for signs that consumer spending can sustain the recovery after the effects of Obama's $787 billion stimulus and other temporary factors wane.

No it hasn't.

Look, let's do it again, shall we?

I stand outside my local credit union (note that this is not a bank and you shouldn't be the customer of a bank either, but that's a story for another time.) I have a net worth, standing there, of $100,000 - that is, assets minus liabilities = $100,000.

I walk into said credit union and take out a $20,000 loan. The credit union hands me $20,000 in cash, and I sign a promissory note for the $20,000. It carries an interest rate of 10%.

I now walk back out of the credit union.

Has my personal economy grown or shrunk?

Neither. It is exactly as it was 10 minutes previous. I have $20,000 in cash but I also have an exactly equal liability of $20,000 in the form of the promissory note. My net worth has not changed a nickel.

Ok, fast-forward a year (irrespective of whether I spend the 20 large or put it in my safe.) Has my net worth grown or shrunk?

It has shrunk, because I owe $2,000 in interest! My net worth is now $98,000 - assets minus liabilities - all other things having not changed during the intervening year.

When the government borrows and spends it impoverishes the economy over time - it does not "grow" it. I will, of course, spend every dime that the government "gives" me without strings attached (e.g. welfare, AFDC, etc) because such money is "free" (or at least it looks that way.)

There are those who argue that if I'm a government I can literally print my way to prosperity, because the government has the ability to use seignorage - that is, the ability to effectively create money out of nothing (other than the trivial cost of paper and ink compared to the face value.) These people ignore the fact that such economic models only work in a world where there are no cross-border flows, no competing currencies and no need for trade beyond one's own borders. In such a circumstance seignorage is effectively "free" all the way up to the point that confidence in the currency collapses.

But in the real world none of these things are true. For each dollar "printed" (or borrowed into existence at interest) the value of all existing dollars is debased. This debasement may be balanced by price inflation internally, but one cannot control the perception of the international community, or those who denominate their debt (and assets) in something other than dollars. Worse, one cannot control the perception of dilution that existing dollar-denominated debt holders will take from such an action - that is, the perception that due to simple supply and demand mechanics a bondholder will fail to be compensated for the debasement of the currency by the coupon paid.

Government can lay the preconditions for expansion of commerce but government itself, when it spends, does not create net commerce. That is, for each dollar of commerce government engages in it either taxes or borrows that dollar from the economy in general, and that's one dollar of private commerce that does not take place. This function of displacement applies irrespective of whether the government can pay its debts or not.

When the government uses its power of taxation (or borrowing) to build a road over which flow trucks and cars the private economy can then leverage the existence of that road to increase the net amount of commerce that takes place. But this presumes that the private economy has leverage available to it - and that, in turn only happens if the earning or borrowing capacity has not been so impaired as to make such expansion impossible.

Both private and government "economists" fail to recognize and account for the fact that each actor in the economy has a limit to the amount of debt they can reasonably carry, whether that actor be private or government-related. Thus, the economy as a whole has a debt limit beyond which it cannot carry itself. As the weakest members in the economy saturate their debt-carrying capacity calls for lowering of interest rates rise in their cacophony in an attempt to prevent these weaker actors from defaulting, exposing the fact that the stronger members have made imprudent lending decisions.

If these calls are heeded then the central bank in effect puts a ceiling on interest rates beyond which neither it or the market may ever again pass without causing the implosion of that part of the economy.

If you surmise from this that such "one way doors" are traps that ultimately lead to Depressions, you're right.

Exponential functions - that is, compound growth and compound interest - mandate that this never, ever be the response by a government or central bank to economic stress. Instead the correct and indeed only defensible response on a mathematical basis is to allow the recession to take its toll and run its course even though such is politically unpopular.

Failing to do so results in the setting of a ceiling on interest rates through the economy which ultimately forces the choice of a deflationary collapse or complete destruction of the currency (and often the government itself!) whether the government likes it or not.

The alleged purpose of an "independent central bank' is to give them the ability to do exactly this - to be able to navigate a world of exponential functions in a world where politics tries to demand violations of the laws of mathematics, and instead say NO to the demands for ever-looser monetary policy.

The fundamental problem is shown in the graph I have reprinted many times:

The longer you allow the spread to continue without a recession forcing the weakest lenders and borrowers to default, the worse the separation gets and the more pain you must take, both in absolute and percentage terms.

Look at the 10% spread line. At five years you must contract lending by less than 50% to come back into line. But at ten years it is not twice as much in gross terms - it is more than three times as much. At twenty years it is not four times as much, it is a staggering amount of nearly seven times as much, and it just gets worse from there!

We have spent a literal two decades trying to avoid the inevitable consequence that must flow from all monetary systems where lending occurs. Lending always involves interest because nobody lets you use their capital for free. Lending at interest always occurs at greater than the long-term growth rate because nobody will give you use of their capital for less than they can grow it on their own in the economy.

Therefore, the spread between debt and GDP is always positive, and this means that recessions are necessary in order to avoid either deep depressions or destruction of the currency and economic system involved.

We have not cleared the bad debt, but instead have tried to hide the fact that the consumer has hit the wall. This has resulted in numbers that are statistically accurate from the government showing "growth" but for the man on the street are meaningless since he is still broke as a consequence of suffocating under his debt load.

Worse, we are threatening to embed into our government structure a requirement that interest rates remain at or near zero indefinitely as a direct and proximate consequence of refusal to stop deficit spending.

Should that actually occur you can say goodbye to America's system of government and economy - we then only debate the timing, not the outcome.

EU Finance Ministers To Obama: Sit And Screw

nospam@example.com (Karl Denninger) — Tue, 16 Feb 2010 08:37:00 -0500

You have to love the audacity of hope:

Feb. 15 (Bloomberg) -- European Union finance ministers are uniting to oppose President Barack Obama’s proposal to limit banks’ size and risk-taking, saying his plan may run counter to EU policy, according to a draft document.

Awwwwww....

So let's see, Brussels thinks that it's perfectly ok for banks to:

Engage in trading against their client's interests.
Create tricky derivatives that, at their core, exist only because someone is shorting a given asset - yet the offering prospectus for those buying said instrument does not say "this instrument only exists because a highly-sophisticated investor wanted a means to bet that what you're buying will implode." Note that this is exactly the opposite of a traditional IPO or Debt Offering in which the premise is that the asset underlying the security is good. That is, these banks are selling securities that if the intent of the creator is realized, will be worthless. How can this be legal?
Have and maintain a financial system that, according to Jamie Dimon himself, has a crisis every five to seven years. Really Jamie? How come we didn't have one for fifty years - from the 1930s, when Glass-Steagall was passed, until the 1980s? Might that have something to do with the progressive dismantling (and outright circumvention) of that law?
Have entire nations in your so-called "union" that appear to have intentionally cooked the books for the purpose of entry into the EU, and who appear to have solicited major banks (including Goldman) to help them cheat on their accounting in order to do so. Oh, and you still (thus far anyway) appear to be willing to allow Goldman (and these others banks) to continue to do business there as well, despite their obvious involvement.

How about this? How about if you keep all those tricky derivatives, banks that screw their customers (on purpose!) and a financial system that threatens to blow the entire economy to bits every five years.

And how about if we, The United States, erect a giant middle finger in your direction, and instead reinstate Glass-Steagall and then mandate that any firm that does business with or in the United States honor and obey our laws, with the penalty for failing to do so being prison time for the offenders - all of them, including those very same pinstripe-suited bankers.

I'm sure we can find wider pinstriped suits that will fit them.

Of course then I woke up.

Partisan Attacks WILL NOT Solve The Problem

nospam@example.com (Karl Denninger) — Fri, 12 Feb 2010 09:15:00 -0500

Ann Coulter, one of the most-partisan commentators out there in the media, had this to say recently:

How about just punishing the guilty? The Democrats can't do that because the list of Wall Street's biggest offenders may turn out to be eerily similar to the list of Obama's biggest campaign contributors.

How about punishing the guilty Ann? How about punishing one JOHN JACKASS MCCAIN, who Henry Paulson personally credits for being the reason TARP passed?

"As he was falling behind in the polls it would have been very easy for him to demagogue that issue, playing the populist card," he said. "And if he had come out against what he were trying to do we wouldn't have got it I believe. We wouldn't have had the TARP legislation passed and we would have been left defenseless."

Oh wait! Henry Paulson was a Republican Treasury Secretary too!

Employees from Goldman Sachs gave more to the Obama campaign than any other organization except the University of California -- with Citigroup and JPMorgan Chase quickly following in sixth and seventh place.

Absolutely correct. Goldman gave money to the winner. Big stinking surprise - NOT.

Whatever Obama has in mind for punishing the financial industry, I promise you, he won't punish his friends. After JPMorgan CEO Jamie Dimon took a $17 million bonus this week, and Goldman CEO Lloyd Blankfein got a $9 million bonus, Obama said he didn't begrudge them their bonuses, saying, "I know both those guys."

Well that may well be true, but can you point to anything that Republicans did in their eight years in office prior to President Obama that actually reined in the outrageous fraud and abuse served up upon the world's investors - not to mention everyday Americans - by Wall Street?

Let's see.... I think I'll list a few things that the Rethuglicans have done to our nation, since Ann has done such a great job of bagging on the Democraps.

"Bankruptcy Reform" - but only for "the little people" - that is, you and I. We can't declare bust if we have a good income and discharge all our debts - but corporations still can!

State laws prohibiting predatory lending: Who directed their justice department to file suit to block these laws? That would be George W "I hope you get bit by a snake on your ranch" Bush, right? Yep. Ann charges:

Obama, like the rest of his party, is an ideologue who doesn't understand or particularly like the free market. He fundamentally believes in the efficacy of the welfare state, whether the beneficiary is a layabout single mother or a rich Wall Street banker.

Oh really? Obama voted against the bankruptcy screw job Ann while he was a Senator. You forget that, right? Yes, he didn't have much Senatorial record, but he did have that to his credit.

Further, "the free market" that Ann promotes under "Rethuglican" administrations turned into "I can rape you so long as I wear a ski mask and you can't identify me."

That's the Republican's view of a "free market."

I'm not saying that the Democrats have a particularly better view of it, by the way. They'll just stick you up face-first, stuffing the gun up your nose while having their way.

In either case you get violated but at least with the Democrats it seems you get kissed first - even if the kiss is delivered by cold steel.

But instead of AIG going bankrupt and Goldman taking a hit, the U.S. taxpayer made good on AIG's securities insurance. In a deal arranged by former Goldman CEO and current Obama BFF, Hank Paulson, Goldman ended up being paid -- by you -- an astonishing 100 cents on the dollar.

Uh, who's Treasury Secretary was Henry Paulson again Ann? Have you gone insane or did you just need to avoid bagging on the progenitor of this train wreck - George W. Bush?

More to the point, why didn't Bush fire Paulson in September - or even sooner? He was still President then, you know - two little words that he refused to speak Ann. One can only conclude that Bush was perfectly happy with Hank's looting - er - "performance."

See, it was Bush's SEC that admitted Hank Paulson (while he was running Government Sachs) to their august chambers and then, at his request, removed the leverage limits that formerly constrained investment banks. Bear Stearns and Lehman Brothers both collapsed due to this excessive leverage - they each had more than double the former legal limit when they blew up. But for the BUSH SEC decision, neither would have collapsed and, more importantly, the last three years of the Housing Bubble could not have occurred.

Those last three years, by the way, were the most toxic. They also featured the famous Goldman "Abacus" CDOs that weren't really backed by anything other than a hedge fund deciding it wanted to short residential subprime - of course that little fact wasn't disclosed clearly and promiscuously to the poor bastards that were unfortunate enough to believe that Goldman was actually selling valuable securities to them in the form of those Abacus tranches! They got violated too, courtesy of the great Republican "Free Market" that Ann feels is so defensible.

Now it's a bit unfair to just bag on Goldman, although they're certainly a popular whipping boy. See, they were hardly alone. Countrywide "Fast and Sleazy" Financial anyone? Got a pulse? Buy a house! Lehman, Bear, Countrywide, New Century and dozens more - all ranged the American land, picking the pockets of millions through trickery, deceit and worse with explicit support and active legal interference run by The Bush White House.

How about Ben Bernanke? Who appointed him? Oh, that would be George W. Bush, right? Do the limits of The Federal Reserve Act mean anything? Apparently not - if you're a Republican.

Ann finishes with this:

Republicans should defend any investment houses that never benefited from a government bailout. But anyone who took huge gambles, lost and got bailed out with taxpayer money should be tortured and then shot, miraculously brought back to life, tortured some more, then shot a few more times.

When Ann is prepared to begin her list with Hank Paulson and Ben Bernanke, along with John McCain (who Paulson asserts could have single-handled stopped the bailouts) I might tend to agree with her.

Her web page runs an ad for a T-shirt that says "I'd rather be waterboarding." I can't agree more. We can start with the aforementioned jackasses who destroyed The American Economy, beginning with the top of the pyramid - those regulators who, under the Bush White House, watched investors and ordinarily Americans alike be serially violated by every Wall Street Bankster and their minion scammers scattered across the "fruited plain", denuding it to feed their yachts' thirst for fuel - and the new house in The Hamptons.

Oh, and Ann might want to consider that had RINO McCain actually done this he'd have 1600 Pennsylvania Avenue stamped on his envelopes - as his return address.

We will not solve this problem until we put away the partiscam garbage that people like Coulter run and face reality: BOTH political parties are equally guilty in this regard. Both embraced the mathematically impossible for more than two decades as a means of disguising and justifying their profligacy when it comes to public spending (Medicare Part D anyone?), either failing to understand or simply ignoring the realities of compound growth and interest.

Now, trapped in a box of their own design and construction Republicans and Democrats alike are trying to eat one another in a partisan flame-fest that accomplishes exactly nothing other than making the problem worse. Neither is willing to accept that we have made promises we cannot keep - and thus we must be straight with The American People and tell them we are breaking them so they can prepare to be on their own in this regard. Neither will cut the cord from Wall Street to Washington DC - there are 200+ year old fraud statutes that are more than sufficient as the predicates to bring charges for the most-egregious acts of these "Masters of The Universe" during the bubble years - we need no new laws, the existing, old-fashioned ones would do just fine.

No, President Obama's plans, along with those of Harry Reid and Nancy Pelosi will not make things better. But neither will claims that The Republicans have a "better idea."

I've yet to hear either party stand up and say "if you ripped someone off during the last decade, no matter how you did it, you are going to jail!" as the central theme in their campaign, yet that is exactly what we need to hear - across this land - if we are to reclaim this nation from the brink of a financial collapse that still looms large to this day.

What The Hell Is Wrong With People?

nospam@example.com (Karl Denninger) — Thu, 11 Feb 2010 15:08:00 -0500

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Whistling Past The Graveyard We Be.....

nospam@example.com (Karl Denninger) — Thu, 11 Feb 2010 10:26:00 -0500

Jonathan Weil of Bloomberg has woken up to what I've written about for nearly three years now in The Ticker - that so-called "balance sheets" are and have been a pure act of fiction, yet it is impossible to find a cop anywhere.

Other banks, Paulson wrote, balked at an industry-backed rescue because “they knew that to make the math work, they would have to make a loan secured by assets worth much less than their stated value.” In describing one pile of bad investments, Paulson said these “had been carried by Lehman at $52 billion, but after their analyses the firms estimated their value at closer to $27 billion to $30 billion.”

In short, Paulson said, “the investment bank had been loaded with toxic assets worth far less than the value at which they were carried, creating a capital hole.”

Paulson’s account is as lucid an explanation of why Lehman blew up as anyone has written. It does leave you wondering, though, if it ever occurred to him to tell anyone at the Securities and Exchange Commission or the Justice Department that Lehman’s accounting might need to be investigated. His book provides no indication that he did.

Of course not.

That's because Lehman is not the only bank involved here. Indeed, not only was this a past transgression it is clear that it's a present transgression.

Was not the entire purpose of getting rid of "mark to market" accounting in early 2009, without which we were told the entire financial system would turn to slag and melt around our ankles, all about balance sheet fraud? About financial institutions that were carrying "assets" at values that could not then (and still cannot now) be justified based on their market price?

What else is "mark to market" but a demand that one's balance sheet accurately reflect the market value of what you hold?

The requirement that publicly owned corporations disclose complete and accurate financial reports is part of the bedrock of U.S. securities laws. Just as important is the promise that the government will enforce those laws when they’ve been broken. Undermine the public’s faith in either of those functions, and confidence in the capital markets crumbles.

Uh huh.

While I applaud Jonathan for coming to this conclusion he is nearly three years behind those of us who have been screaming about this very issue since 2007 - or even before.

Indeed, The Ticker began publication in no small part because this "little bitty bank" called Washington Mutual was paying dividends out of capitalized interest - that is, negative amortization - on loans to homeowners in California that were already underwater in 2007, and thus were rather unlikely to ever be paid - never mind that capitalized interest isn't cash, it's an accounting entry, yet you have to pay dividends with actual money!

This is at the root of why I have said for the last three years that it is not possible to invest in today's capital markets, because it is not possible to trust a balance sheet.

Even companies that are allegedly "Strong" and have "No material exposure" are doing tricky things - witness CISCO's recent disclosure that it is funding customer financing at below-market interest rates (zero!) with off-balance sheet vehicles.

We have learned exactly nothing from MCI/Worldcom and ENRON. We not only learned nothing we have allowed corporations to repeat the precise same sins that detonated both of those firms, we have papered over the losses and fictions that were hidden from investors and we have failed to hold executives and boards to account for committing this sort of trickery.

What's worse is that we're still doing it, nearly three years into this mess, and if anything the fictions that infest our corporate balance sheets in America have gotten worse, not better, in the intervening three years.

It is a fundamental tenet of the capital markets that one's financial statements must accurately reflect all material income streams, exposures, liabilities and assets to which a firm is exposed in a form and fashion that they can be independently analyzed. Without this it is absolutely impossible to form an opinion that can be defended on the value of that entity, and thus their stock price and even their status as a going concern is nothing more or less than a casino game where the dealer has marked cards unknown to the player and can deal off the bottom of the deck besides - all with the knowing and willful blindness of the alleged authorities that are supposed to prevent this sort of raw abuse.

Update: Jonathan has taken apparent umbrage at my suggestion that he's "late to the party" and has sent me a host of articles of his (some of which I've opined on in the past) representing his opinion on same. I maintain that this is the first time I recall him talking about The Justice Department - that is, possible criminal charges.

Lest one think that recognition is a bad thing I will say for the record that it most certainly is not and I hope it continues. I simply note that there have been damn few people asking where are the cops on any sort of consistent basis, and civil lawsuits (e.g. "Where's the SEC?") with their nearly-always-settled complaints that inevitably wind up being charged back to the shareholders, thereby abusing them twice, may be a good start but is nowhere near as good a tonic for the outrages we have suffered as a people as would be orange jumpsuits.

The Audacity Of Synthetics

nospam@example.com (Karl Denninger) — Tue, 09 Feb 2010 12:25:00 -0500

DeepCapture has picked up something I've written about before, but none of these folks seem to put together the "big picture", as I outlined yesterday on my Blogtalk show.

As Fiderer explains, Paulson asked the banks to create those CDOs “so that they could be sold to some suckers at close to par. That way, Paulson’s hedge fund could approach some other sucker who would sell an insurance policy, or credit default swap, on the newly minted CDOs. Bear, Deutsche and Goldman knew perfectly well what Paulson’s motivation was. He made no secret of his belief that the CDOs subordinate claims on the mortgage collateral were close to worthless. By the time others have figured out the fatal flaws in these securities which had been ignored by the rating agencies, Paulson could collect up to $5 billion.

Let's step back a second.

A "CDO", or "Collateralized Debt Obligation", is in theory a very simple instrument. It is, at it's core, a collection of income-producing "assets" that have a cash flow that can be diced up paid to people who have purchased components of the CDO.

The usual thought process when someone says "CDO" is that some bank bought a bunch of bonds, compiled them into a CDO and then sold off the tranches.

The CDO itself is typically held off-balance sheet in a SIV/SPV, lest the bank be forced to recognize it as part of it's "assets." This is permissible because the bank doesn't own the assets, the legal entity does, and it got the money to buy them from the people who bought the tranches that were issued. The banks do this because they get a nice fee for filing the papers to establish the entity along with a management fee to act as the servicer - that is, the "guy in the middle" who takes the money that comes in from the debt instruments and slices it up, paying out those funds to the buyers of the CDO's tranches.

So you can think of a CDO, in it's simplest form, as a way of taking a bunch of bonds, putting them together, and then deciding by some mathematical formula who gets the lion's share of the risk in those bonds, along with (of course) the larger set of the rewards.

But of course in "structured finance" nothing is ever as simple as it seems.

Remember what I said up above?

A "CDO", or "Collateralized Debt Obligation", is in theory a very simple instrument. It is, at it's core, a collection of income-producing "assets" that have a cash flow that can be diced up paid to people who have purchased components of the CDO.

Who said that the "assets" had to be actual bonds?

A synthetic CDO is, as the name implies, not made up of actual bonds. Instead, the issuer writes a naked credit-default swap on the underlying reference(s) they use.

The buyer of that CDS pays a premium, usually in the form of an annual payment (and sometimes something up front too.)

BINGO! We have "a thing" that throws off an income stream and thus can, and does, form the basis for a CDO!

The "CDOs" that are at issue here were synthetics.

That is, they did not own actual bonds, they were comprised of credit-default swaps that Goldman wrote against subprime mortgage bonds.

This would have left Goldman exposed (as the writer of the swaps) for the potential losses. Goldman, in turn, bought a CDS from AIG against the "portfolio" in the CDO, thereby laying off the risk on AIG.

Goldman is thus now "net neutral" (provided AIG can pay!) and happy as a pig in slop, as they made money on the origination fees for the CDO and in addition get to skim a nice little bit off the servicing.

What could possibly go wrong?

More than a few things.

Let's start with how this CDO got funded. Remember, it got originated by Goldman writing a bunch of credit-default swaps. Who bought them? Someone had to think subprime was going to detonate, because they paid good money for "protection" that would go up dramatically in value if it did, but for which they were going to pay the CDO investors good money if it did not.

It appears that the buyer of those credit-default swaps was, perhaps, John Paulson:

“Paulson not only initiated these transactions, he also specified the terms he wanted, identifying which mortgages would be stuffed into the CDOs, and how the CDOs should be structured. Within the overall framework set by Paulson’s team, banks and investors were allowed to do some minor tweaking.”

Ah, so the allegation contained here is that John Paulson (of hedge fund fame, not to be confused with Hank Paulson the ex-treasury secretary) combed through the pile of subprime mortgage bonds that were out there and handed Goldman a list of "what I want in there", then offered to buy the Credit Default Swaps that would pay out at a huge multiple if and only if those underlying bonds failed to perform.

In other words Paulson combed through the data available on these subprime mortgage deals and picked out the crappiest of the garbage - the most-rotting of the dead fish, all of which allegedly were "AAA" at the time one would presume but which he was quite sure would soon be either downgraded - or default outright - and then asked Goldman to use those as the references against which it would write the swaps that Paulson wanted to buy.

But remember - Goldman didn't buy the bonds to set up the CDO - they just issued a credit-default swap, which, it appears, Paulson's hedge fund bought.

Goldman then went out and solicited people to buy the tranches of the CDOs, selling what was alleged to be a cash-flow stream that Mr. Hedgie had offered (out of the goodness of his heart, no doubt - ed: yes, that's sarcasm) to fund!

Here's the question:

Did Goldman disclose to the potential buyers in the offering circular that John Paulson had come to them with a laundry list of characteristics he wanted in the CDO and offered to fund the credit-default swaps which would only make him money if those reference bonds blew up, and that he would take large, material losses IF THE SECURITIES - AND THE CDO - PERFORMED AND ACTUALLY GENERATED THE CASH FLOWS PROMISED?

I don't have a copy of the offering circulars for these CDOs. Perhaps someone does and can forward them to me.

But somehow I find it hard to believe that it was made clear to the buyers of these tranches before they plunked down their money that these CDOs came into existence because a wise guy came to the bank and asked for them to create a synthetic CDO with specific characteristics and that they would provide the cash flow to be paid to their investors - but that the essence of their desire in setting this up was that they believed the reference instruments would default and in doing so they would become rich while the tranche buyers would be left with little or nothing!

You can say that the buyers of the CDOs should have done their due diligence. Ok, I'll grant you that. You can also say that the ratings agencies had no business granting "AAA" ratings on underlying securities with such shaky repayment prospects, and I'll agree with that too.

But this leaves open the question of whether it is fair, just, or even legal to create a synthetic security that at it's core comes into existence because someone believes that the reference is going to detonate, and then sell off pieces of that security to investors without prominently disclosing the source of the funding of the cash flow, that they proffered the criteria for inclusion in the reference and that the INTENT of their funding was to profit from an EXPECTED detonation of the reference securities.

It also leaves open the question of laying off that risk on an insurance company (whether in a regulated subsidiary or not) without similarly disclosing the above to them up front! That is, is it fair, just (or even legal) to buy fire insurance on a property when you have been told that someone expects a fire in that structure based on what they believe is credible analysis (e.g. a look at the wiring plan), without telling the insurance company about what you were told?

I don't have answers to the questions about the propriety or legality of these actions. But I can opine on my view of the ethics involved in such a set of transactions by a bank, and that's easy: this, in my opinion, is nothing more or less than intentionally screwing people. That is, this is not about "intermediation" or any such claptrap - it was, in my opinion, a pure act of financial rape-for-profit.

These sorts of "naked" positions - whether in the form of a raw naked Credit Default Swap or in the form of a "synthetic" CDO - must be barred for creation, trading, management and handling in all of their forms by any entity subject to any form of federal or state regulation or backstop, including but not limited to banks, insurance companies, pension funds and similar entities.

If hedge funds wish to bet amongst themselves on the life (or death) prospects for a given reference security, let them do so. I don't care one whit if John Paulson is right or wrong - he's entitled to place his bets and make (or lose) money as fate and skill dictate.

But he should not be entitled to solicit a bank, investment or otherwise, to peddle off securities to others and obtain what amounts to insurance on their performance, while not fully disclosing to everyone involved that THE VERY REASON THIS SECURITY EXISTS is that he wanted to place a bet that the reference on which this security was based would detonate, and that if he is correct in his analysis THOSE WHO BUY AND INSURE THIS "SECURITY" WILL FIND THEMSELVES HOLDING A PILE OF USED TOILET PAPER.

Krugman Finds His Nut(s)?

nospam@example.com (Karl Denninger) — Wed, 10 Feb 2010 13:55:56 -0500

As in "a blind squirrel finds one - once in a while."

(With apologies to the person who posted it on TF under that title before I got to Tickering this - heh, I had to go get my teeth cleaned, so give me a break already! :))

But in fact Krugman hasn't found his nut(s), although he should check. He's groping around down there.... perhaps he could come up with something if he'd just take the next logical step from here:

The point is that these bank executives are not free agents who are earning big bucks in fair competition; they run companies that are essentially wards of the state. There’s good reason to feel outraged at the growing appearance that we’re running a system of lemon socialism, in which losses are public but gains are private.

No Paul, that's not reality either. Your liberal mind just can't get its tiny little wings around what really happened, so let me help you.

You can start with my Ticker entitled "The Audacity of Synthetics", in which I explain to the proletariat what any self-respecting "economist" (or "economic reporter") should already know about, but which I've yet to hear you opine upon:

But this leaves open the question of whether it is fair, just, or even legal to create a synthetic security that at it's core comes into existence because someone believes that the reference is going to detonate, and then sell off pieces of that security to investors without prominently disclosing the source of the funding of the cash flow, that they proffered the criteria for inclusion in the reference and that the INTENT of their funding was to profit from an EXPECTED detonation of the reference securities.

It also leaves open the question of laying off that risk on an insurance company (whether in a regulated subsidiary or not) without similarly disclosing the above to them up front! That is, is it fair, just (or even legal) to buy fire insurance on a property when you have been told that someone expects a fire in that structure based on what they believe is credible analysis (e.g. a look at the wiring plan), without telling the insurance company about what you were told?

THAT is what happened Paul.

These Banksters didn't just make bad bets, have them blow up in their face, and then come crying to the government.

Oh no.

They, for various purposes (all of which devolve down into "profit for me!") created securities of various sorts, many of them with no actual asset behind them but rather pure gambling contracts, and then sold them without disclosing everything they either knew or should have known in a full, fair and reasonable fashion to the people they sold them to.

Do you care to re-think exactly how outraged you ought to be Paul?

More Bleating: Small Business Loans

nospam@example.com (Karl Denninger) — Sat, 06 Feb 2010 17:57:00 -0500

Here comes the whines - once again - on small business lending:

WASHINGTON—U.S. regulators Friday urged banks to continue lending to credit-worthy small businesses, responding to growing criticism from Capitol Hill and the White House that regulators' aggressive post-crisis supervision is cutting off credit.

The Federal Reserve, Federal Deposit Insurance Corp. and other state and federal regulators in a joint statement said they were concerned about the contraction in lending to small businesses as banks respond to the financial crisis by tightening lending standards.

I can speak to this because, well, through most of my adult life I've operated and owned a small business in some form or fashion.

When I was in my 20s I formed Macro Computer Solutions, Inc. A subchapter S corporation that had two owners and shareholders, it was the prototypical "small business." We did data wiring, consulting work of various sorts and sold white-box PCs to local businesses in Chicago - including a firm that was later acquired by Waste Management.

It was a decent living, but a hard-working one. Neither of the principals (myself included) had much. I had almost nothing - literally. A paid-for car, some personal possessions, a few thousand in savings. That's all. The other guy had a house with a big fat note on it, a couple of cars, some personal possessions, a wife and a dog. Really.

Regular guys trying to make it all work.

Loans? You're kidding, right? With what for collateral?

Eventually we split up the company and closed it. I went to work for a Fortune 50, he went to work for a large national association, both doing what we knew how to do. We didn't close because we were forced out, but rather because we were made better offers for our time.

The name (Macro Computer) was one of the things I got to "keep" when we split things up. It later was re-filed first as a DBA and then as an S-corporation, later converted to a "C". That incarnation of the firm - with myself as the controlling shareholder - was the one that operated MCSNet, the Internet provider.

A couple of times I went to talk to banks about loans. But once again, I didn't have a lot in the way of assets. Oh sure, I had the company, and it had receivables and assets, but I didn't personally have much. Certainly I didn't have $100,000, $500,000 or $1m in "home equity" that I could pledge - I was a renter for a good part of my time as a CEO. I had some cash, but cash can be spent quickly, right? I might want a new boat, or an expensive car. Who could possibly know?

What was the answer to my inquiries? Simple:

And why wouldn't it be? Remember, lending - sound lending - is based on the "C"s: Capacity, Character, Collateral, Capital and Conditions.

I had capacity, economic conditions were good, and my character was fine - I had no record of screwing people over and my credit record was excellent.

But I lacked both collateral and capital personally, and if the business had the capital why would it need the loan?

What's being asked for here is for lending institutions to dispense with the 5Cs of credit and instead write loans based on phantom collateral and absent capital.

Let's face it - if the principals of the business have the capital or collateral why don't they take out the loan in their own name or loan the business their capital (at interest) and bear the risk?

The answer to that is obvious, isn't it?

Later in the 1990s of course people were falling over themselves to lend me money with no capital or collateral required. Lucent offered to "sell" me literal millions worth of telephone and data switching equipment "on credit" either as a capitalized lease or on a "payment plan" that was effectively zero-interest. Guess what? It destroyed them when those loans to businesspeople that never should have gotten them blew up in their face.

I learned an important lesson from all this in the late 1980s and 1990s - you don't really need loans to set up and operate a small business. You need guts and the willingness to work long hours and take risk. Personally. Yes, you'll grow slower. So? You'll own what you earn - it will be yours, not the bank's. You'll keep your opportunities to yourself, instead of always looking over your shoulder. And when the time comes to expand, whether it be by buying more stuff, adding employees or moving to a new, larger location you'll do it based on cash flow, not on whether you can make the minimum payment on some note and pray that you'll be able to roll it over at reasonable interest rates in a year or two.

Folks, this bleating is backwards.

I ran businesses in multiple areas of operation for more than a decade and never once did I take a bank loan. We paid people out of our business checking account, we had normal Net 30 commercial credit terms with suppliers, and we invoiced people we did work for. Yes, there were times that the checkbook was lean - very lean - and a few during which I wondered if we'd make payroll. But we did it, and when MCSNet really took off it meant that instead of being a slave to some banker behind a desk, I ran the place the way I thought it should be run, I made expansion plans based on what I believed to be reasonably-attainable goals, and I bought hardware with my checkbook instead of trying to figure out whether I could make payments factored by "growth rates" based on some fantasy.

This bleating from places like The Wall Street Journal and the crackpots of advocacy is misplaced. If you're a small businessperson and you can't make a go of it without unsound loans - that is, loans made without full regard to the 5Cs - then you shouldn't get the loan. Most of you shouldn't take the loan whether you can get it or not - the interest costs are just a millstone around your neck that will restrain both your choices and profitability in the future.

The day of the Ponzi is over folks.

Grow organically, manage your cash flow, and ask yourself this - if you lack collateral or capital, why should someone else loan it to you if you're not able to pay it back?

If you don't lack capital or collateral, why is it that you want someone else - in this case a bank - to take risk with THEIR capital you won't take with YOURS?

Robert Reich Failed Home Economics

nospam@example.com (Karl Denninger) — Fri, 05 Feb 2010 10:11:00 -0500

Really.

You know that class that was required in "High School", and was largely responsible for it having its moniker - because you could literally be stoned through it and get a 100?

Well Reich failed, because he couldn't balance a checkbook.

Alright class, here's your assignment: Look at President Obama's budget proposal, spending freeze, jobs bill, stimulus, tax hikes on upper-income individuals, and proposed deficit commission. Also take a look at the fees he wants to impose on the biggest banks, and his proposed regulations of Wall Street. Look at his stalled trade agenda. Now, explain the big picture.

Ok, I'll take a shot:

$500 billion in newly-embedded STRUCTURAL deficits in concert with rapidly-falling tax revenues = ultimate insolvency of the US Treasury.

Oh wait, you didn't like that answer. Here's what Reich said:

If you're about to write "more taxes and more spending," you're either not thinking hard enough or you're a Republican running for office this November.

To see the big picture you need to keep your eye on three big things. The first is the extent of government spending needed to offset the continued reluctance of consumers and businesses to spend.

It's not reluctance. It's inability. That's usually what happens when your general mantra is "I can't be out of money - I still have checks left!" and then try the same trick with your credit card only to have it come back "REALLY DECLINED."

You don't have to be an orthodox Keynesian to understand that as long as the private sector is deleveraging the public sector has to borrow and spend in order to keep the economy moving forward.

I don't have to have an IQ larger than my shoe size to understand that when the private sector has reached it's leverage limit it is not possible to "spur" it to take on more leverage - that is, to borrow and spend that which isn't earned in the present tense.

All government borrowing and spending does in that case is make the ultimate deleveraging (across the entire economy) WORSE.

Of course those who pray at the Keynesian altar (or for that matter, virtually all the other altars when it comes to economics) don't have "D" (debt) anywhere in their economic calculations and pronouncements.

Their error is primary - they believe in "MV = PQ", but think "M" is the money supply. It's not - it's the credit supply, but for each dollar of credit there is one of debt, and when the ability to carry that debt reaches its limit you have hit the economic wall and "P", "Q" or both must CONTRACT.

Reich, I'll issue to you you the same challenge I issued to Krugman - want an hour-long debate with me on Internet radio? This coming Monday or any Monday - simply get ahold of me and I'll be happy to hash it out with you.

It's a hell of a lot harder to influence people when you have to defend your claims rather than just spout off on the opinion page - where nobody has the ability to force you to defend your preposterous claims.

Krugman Displays Liberal Idiocy

nospam@example.com (Karl Denninger) — Fri, 05 Feb 2010 09:45:18 -0500

Can someone revoke this jackass' degree?

Or perhaps I should award him an honorary degree in lying?

Just one paragraph please...

Let’s talk for a moment about budget reality. Contrary to what you often hear, the large deficit the federal government is running right now isn’t the result of runaway spending growth.

Really Paul?

How about some facts instead of lies?

Argue with The Fed if you'd like Paul, but unless you're prepared to have a discussion on the actual facts, shut the hell up.

PS: Your claim about interest costs being "manageable" relies on foreigners being willing to continue to lend the Federal Government money for a near-zero interest rate while at the same time our labor force is collapsing. Bonne chance mes amis.

PPS: Here's an open challenge to you - want to come on for an open debate with me on Internet Radio? Bring your best rapier - you'll need it.

Pizazz Over Safety = Disaster

nospam@example.com (Karl Denninger) — Tue, 02 Feb 2010 22:51:00 -0500

Here we go again on the Toyota issue:

Feb. 3 (Bloomberg) -- Electronic throttle systems are under review by U.S. safety officials as a possible cause of sudden acceleration in Toyota Motor Corp. vehicles, as alleged in at least seven lawsuits.

I wrote on this the other day in which I opined:

But not all cars can "run away" in this fashion, and it can be argued that none should. Indeed, it can be argued that that any vehicle with a drive-by-wire system MUST have a means of intuitively overriding an "un-commanded" acceleration in order to be considered reasonably safe and thus able to be certified for sale.

Now I happen to think that all drive-by-wire throttles should be interlocked with the brake pedal. Put a means to install an override on it if you want (rally drivers will complain if they can't get one) but for ordinary street use this is something that just plain old-fashioned ought to be there.

If I stomp the brakes the throttle should be returned to idle. Period.

In my VW Jetta Wagon it is.

That won't cover the case where the computer goes insane, however.

That is only covered by a mechanical ignition switch that interrupts power to the ignition circuit, and that too should be mandatory.

To use electronic "start buttons" for reason of vanity is outrageous. And let's not kid ourselves- that's exactly what those switches are.

Second, I've been around a lot of dangerous gear in my life with a lot of "emergency stop" buttons all over the wall (or on the machine.) You don't have to hold them in for three seconds to stop the machine, you just hit them and that's it - power's off!

I have a lathe in my shop. It has a big fat RED emergency stop button front and center on the control panel where I can get to it FAST if I need to. It does exactly what you think it should do too - it cuts the power. If I need that machine to stop in an emergency I need it to stop NOW, not three or five seconds later.

Try holding in your "start" button on these newfangled cars for three seconds continually while attempting to avoid playing bumper cars with all the other vehicles that are going half as fast as you are because your vehicle's throttle is locked wide open!

Vanity sounds great until people start dying as a consequence.

We both can and must demand better.

We must insist that all vehicles sold in the United States be fitted with an actual mechanical ignition switch that interrupts powers to the ignition circuit when turned off with a key that is easily reached from the operator's position - not an electronic signal "asking" that the computer turn off power but an actual physical opening of the circuit that supplies the power necessary for the ignition to work.

Way back when (20ish years ago) I used to design and implement computer-based control circuitry to precisely position very big and heavy pieces of equipment. The "business end" weighed many tons and was driven by high-horsepower motors through reduction gearing, with drive systems capable of generating more than enough force to easily rip a man into little pieces (or go right through the side of a building.)

These controllers used optical encoders with differential signals to "know" where the machine was. There were lots of "failsafe" checks in the code, such that if the encoder wasn't returning both differential signals of opposite polarity as expected, if the unit was moving faster or slower than it should be or there were any of a half-dozen other things "not quite right" the unit would shut down and sound an alarm - just like "drive by wire" throttles have a "limp" mode they allegedly go into if they detect some sort of problem.

But in each of these installations I demanded that in addition there were physical limit switches that opened the power circuit DIRECTLY to the motor. That is, if for any reason (such as the computer going insane due to a software or hardware failure) the machine was driven to the limit of its safe travel power would absolutely be interrupted to the motor and it would thus stop before it killed someone or did severe property damage.

To the best of my knowledge none of these controllers or drive systems ever failed in a fashion that actually hit the limit switches, but they were part of what I insisted be present in the design and installation - just in case.

It costs little or nothing to do this. In the present case, with ignition switches, the reason to omit them is vanity - to appear "high tech" or "cool" - not for any particular functional purpose.

That vanity has removed from the driver a capability that he has had for the last fifty years of automobile operation - the ability to absolutely, positively stop a runaway engine in less than one second by turning off the ignition key.

Tell me again which is more important here - safety or vanity?

Roubini, Summers and Obama: Duh

nospam@example.com (Karl Denninger) — Mon, 01 Feb 2010 08:25:00 -0500

Out of Davos come two opinions that Bloomberg (and others) have spun as arguing for "continuing stimulus efforts":

“The headline number will look large and big, but actually when you dissect it, it’s very dismal and poor,” Roubini said in a Jan. 30 Bloomberg Television interview following a U.S. Commerce Department report that showed economic expansion of 5.7 percent in the fourth quarter. “I think we are in trouble.”

Roubini said more than half of the growth was related to a replenishing of depleted inventories and that consumption was reliant on monetary and fiscal stimulus. As these forces ebb, the rate will slow to 1.5 percent in the second half of 2010.

No really? We've embedded $500 billion in annual transfer payments of various forms over the last 18 months. That's about 3% of GDP, or more than the "advance" GDP number says that personal consumption expanded (2.2%)

In other words, but for the additions to transfer payments over what was present before we went into this mess consumption would be printing a solid negative number - still.

Summers said that the "statistical recovery" won't mask "a human recession."

Human recession Larry? Is that like the "mental recession" that John McCain's favored economic wonk proclaimed during the campaign?

Never mind our "good friend" President Obama, who is proposing a $3.8 trillion budget today. In a break with the usual "optimistic" view compared to the CBO, he's predicting that the deficit this year will total $1.8 trillion, or almost 50% of the total federal spending - and that's with more than $800 billion in higher taxes (which have a near-zero chance of actually passing Congress in an election year!)

The President claims to be enacting a "spending freeze" and claims that it is "everything but security and defense." In typical Washington form this is a lie - education and R&D (everywhere) are getting a 6% increase. This, while inflation is currently running at a statistical zero, and on the back of the last year's budget which amounted to a "ratchet up" game played with the voters.

This is the same game, by the way, that was played with the states and their so-called "Federal Help" during the last year. To qualify for "stimulus" payments from The Federal Government they had to agree to freeze spending at 2005 or above levels - right at the top of the housing bubble when their revenues were peaking. This is a major cause of the states currently facing bankruptcy over the coming years.

Obama’s plan also calls for creating a special debt commission to recommend steps to cut the deficit and tougher budgeting rules in Congress.

The result would be a deficit that declines next year to $1.27 trillion and to $828 billion in 2012, according to a summary provided by the administration. In subsequent years, though 2020, the annual deficit would still total between $700 billion and $1 trillion. By 2020, the publicly held debt would approximately double to $18.5 trillion, according to estimates.

Nice musing. But Mr. Orszag said:

“The worst thing we could do is act too quickly and throw the economy back into recession,” Orszag said.

Yeah, well, here's the issue - we haven't fixed a damn thing. There is still far too much debt in the economy, and the Obama "plan" is to try to kick the can one more time, spending more and more at the Federal level in the hope (prayer really) that both the market will tolerate this without ratcheting up interest rates and that somehow we will "find" more debt-carrying capacity and acceptance among the public and corporations.

There's not a snowball's chance in Hell this is going to play out, and for that reason the projections of smaller deficits going forward is pure fancy. At some point Washington is going to have to bite the bullet and force the pig through the python - that is, we must force the debt out of the system. This means accepting that a lot of people - and corporations - must go bankrupt. We must cage the derivative monster. And we must put a permanent stop to ponzi finance in all its forms.

Americans can accept that they blew it and that a trip to the bankruptcy judge is in their future. But what they won't and shouldn't accept is that while they have to take that trip, those banksters yukking it up in The Hamptons who lied about what they were selling don't have to join them there. That's both unjust and unacceptable, and yet we the people continue to refuse to demand real reform and progress, instead allowing the politicians and policy wonks to throw platitudes and borrowed federal dollars around, foolishly believing that this both can and will continue forever, much like the old saying "I can't possibly be out of money - I still have checks left!"

Well, guess what folks: this "plan" won't work. As in 1930 you can either listen to the foolish claims that "it will all be ok; we'll borrow our way to prosperity!" or you can prepare for what is certain to be a cold, hard rain. Summers and Obama remain in denial - a state shared with the rest of the Washington DC establishment that has never been willing to be straight with the people, mostly because doing so in a fashion that doesn't result in an instant revolution requires that they stomp on the bankster games at the same time that the rest of us are asked for austerity - and that goes directly against the "shower of money" that is emitted from Wall Street and finds its home in the politicians' pockets.

We are certainly in for an interesting remainder of the year and beyond, and I can only hope that at some point before we see the bird erected in our direction by the world's creditors we wise up and wake up.

I, for one, am not confident it will happen.

The Light Begins To Wink On

nospam@example.com (Karl Denninger) — Sat, 30 Jan 2010 12:43:00 -0500

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

At the time I said:

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

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

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

And now The New York Times has opined with:

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

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

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

Uh huh.

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

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

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

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

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

This is a false assertion.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Wake up America.

Will We See Bankster Baseball?

nospam@example.com (Karl Denninger) — Thu, 28 Jan 2010 08:25:00 -0500

There are times that I wonder if the looting will keep on until the people express their anger with necktie parties - or worse.

The arrogance of Wall Street knows no boundaries. The latest is on display in these two stories, first from Bloomberg:

Now the firms and their chiefs, confronting a wave of public anger against their bonuses awarded in the wake of the financial industry bailout, are trying to devise a strategy to fight both the proposed new limits on banks’ size and activities as well as the bank tax. While they are still plotting tactics, one thing has become clear: The banks don’t want to go to war with the commander-in-chief.

“We don’t want to fight the administration,” said Rob Nichols, whose trade group, the Financial Services Forum, represents the chief executive officers of the largest financial companies. “We just want to sit at the table and have a productive conversation about the kinds of reforms needed to address the real causes of the recent crisis.”

I'll tell you exactly what sort of reforms are necessary:

No more obfuscation, lies about credit quality, and intentionally peddling things you think are worthless. And don't start that crap about shorting things "as a hedge" when you constructed them - if you're the company that put them together if you're not damn sure they're marketable, you don't sell them. Ever see the sign in a restaurant: "If you're not proud of it, don't serve it"? WELL?
Those who have committed this sin must atone. This means admitting what you did, it means giving back as much money as is left, and it means if you broke the law on top of it pleading guilty and accepting your punishment.
Since "animal spirits" seem to be impossible to tame, it also means breaking up lending and depository functions into what amounts to a regulated public utility. Gamble with your own money - but never with ours, and never, ever with a sovereign backstop. Ever. This means depository and lending institutions may not participate in any way, shape or form in the securities markets - including the purchase, sale, holding or trading of derivatives. Period.
No more "mark to myth" and no off-balance-sheet anything. Every investor must be able to read a balance sheet and have a full and fair view of your firm's assets and liabilities. Period.
Oh, and stop trying to influence Bernanke's appointment - that's reported in this story as well. Attempting to influence the selection of your regulator should be treated as a felony - just like bribing someone - because it effectively is.

This isn't confined to the US either:

Bankers stood shoulder-to-shoulder at the Swiss ski resort of Davos to try to prevent a scatter-gun approach to new financial regulation by different countries.

They united against Barack Obama's threat to break up banks and Gordon Brown's growing enthusiasm for a Tobin tax on all financial market transactions.

Again: Quit stealing.

Or just listen to your buddy from Davos:

The founder of the World Economic Forum has said there is a lack of public trust in political and world leaders.

Klaus Schwab told the BBC that business leaders must show that they serve society to heal this rift.

It's hard to show that when you're robbing everyone you see blind.

Fiduciary Responsibility? Where?

nospam@example.com (Karl Denninger) — Thu, 28 Jan 2010 08:22:00 -0500

One wonders where the pension folks have been for the last couple of years....

Jan. 27 (Bloomberg) -- The California State Teachers Retirement System, the second biggest U.S. public pension, will need to ask taxpayers for more money after investment losses left it underfunded by $42.6 billion.

The pension’s unfunded liability, the difference between assets and anticipated future costs, almost doubled from $22.5 billion in June 2008, according to a report Chief Executive Officer Jack Ehnes will deliver to the board Feb. 5. The fund will ask lawmakers next year for an increase of as much as 14 percent to what the state and school districts already pay toward employee retirement benefits, said the report, which was posted on the fund’s Web site today.

Anyone remember my multiple warnings on this subject, including this one?

This morning I had seen a third "notice" that there are widespread "critical shortfalls" in Union Pension Funds.

I put up a short video on the topic and am now getting emails telling me that this is more widespread than has been reported - additional funds have been sending these deficiency notices out.

Now I'm well-aware that in this specific case the fund will simply "ask" for huge additional public (tax) subsidies. In many states these funds have the standing as constitutional (under the state constitution) debt, and thus will effectively force huge tax increases on state residents.

But one has to ask - who is going to hold these fund managers responsible? How does one manage to lose 20, 30, 40% when you're a professional money manager in the sort of environment where people like me saw it coming and were hollering back in 2007 and early 2008?

Well, whatever the answer is, you can bet this problem isn't going to go away soon. Nor does all the bleating about constitutional this or that (or contractual this or that) matter when there's simply no money.

I wish everyone the best of luck on collecting on these pensions; from what I can see you're going to need it, especially with the ridiculously-rich pension payments that many public employees enjoy.

Dick Bove Has Lost His Mind

nospam@example.com (Karl Denninger) — Tue, 26 Jan 2010 08:12:00 -0500

What is wrong with this guy? Listen to this clip:

How the hell does a guy like this get a job as an analyst?

Does he not remember the debates we had back in 2007 and 2008?

How many of these people have paid any attention to what has actually happened in the banking system? Never mind why we're in this mess, which is the precise thing that Bove is calling for more of - expanding lending!

We're here because of PONZI LENDING. That is, we are in this mess because banks made loans to people that couldn't pay. It is obvious that if a bank has two people it can loan to - one who can pay, and one who cannot - it will preferentially loan to the person who can. It is only when those who are both willing and able to repay their debts are sated - that is, they either can't or won't borrow - that lending gets driven toward those who cannot pay!

Further, Bove makes the statement about 5:30 into this piece where he says that the money supply will always grow faster than the economy.

Well DICK, if that happens then explain how the debt taken on gets paid back! You know, THIS GRAPH?

You want to know why we get crashes in the market? Why we had two crashes in the last decade?

Why WE ARE HEADED STRAIGHT FOR ANOTHER ONE?

It is because of the PRECISE sort of nonsense - that "money will always expand faster than the economy" - that came out of Bove's mouth. That is the essence of the problem, it is the essence of why our economy is hosed, it is the essence of what all the clowns in Washington DC and on Wall Street are trying to pull AND IT IS MATHEMATICALLY IMPOSSIBLE FOR IT TO WORK!

Wake the hell up America. Wake up CNBS! Show this graph. Demand that Dick Bove explain how we can ever have a sustainable, stable economy if we permit this sort of crap to continue!

He won't because HE CAN'T.

Doug Noland: Just Say The Words!

nospam@example.com (Karl Denninger) — Mon, 25 Jan 2010 08:52:03 -0500

Doug Noland over at The Prudent Bear has written a piece that everyone, in my opinion, should read - particularly the section on "The Volcker Rule":

While certainly not without faults, the financial system back in the Volcker era was more stable. The ABS market barely existed. The Wall Street firms and their marketable debt instruments were not major factors in system Credit creation. The banking system dominated the extension of private-sector Credit. Derivatives markets were in their infancy – and certainly didn’t dominate the financial world. Outside of some GSE MBS, mortgage Credit was in the form of bank loans. There were only a handful of hedge funds – not thousands. Leveraging marketable debt instruments wasn’t The Game.

....

One of the big problems today is that there are tens of Trillions of marketable securities out there – and their value depends greatly on the ongoing creation of Trillions more. Our system needs major financial reform – no doubt about it. From today’s Wall Street Journal: “The White House’s relationship with Wall Street is close to the breaking point.” A war on Wall Street would put Credit growth, asset markets and economic recovery all at risk.

Just say it Doug: It's a Ponzi Scheme and thus ultimately must fail, as do all Ponzi Schemes.

I find it amazing how far people will go - describing the essence of the scam, go through it in detail, laying it all out right in front of your eyes - and then they walk right past the obvious (and indeed the only) statement that sums it all up.

All such schemes of creation or maintenance of "wealth" that rely not on the underlying value but on creation of more of the same are Ponzi Schemes. They all must fail because in each and every instance you must continue to find a way to make "more" of whatever you started with in order to maintain value, and as time goes on this "more" grows geometrically in support of what already exists.

This cannot occur forever as a consequence of basic mathematics, which is why all such schemes are supposed to be unlawful.

That is the underlying reason why we must have reform. It is not a matter of one means of profit being "good" or "bad", nor of whether the financial sector is "too big." It is that the structure of finance in this country, and indeed the world, has grown into a blood-sucking vampire that creates more vampires, and thus has turned into a Ponzi Scheme. Eventually it must run out of blood sources simply due to the fact that it continues to expand in size at a rate faster than the productive economy and yet the productive economy upon which it feeds has a limited amount of blood that can be extracted without dying - just as is portrayed in the movie Daybreakers.

We reached that limit in 2007 and that is the root cause of the trouble we got into - and remain within.

Doug is just the latest of many who walks right up to the truth, stares it in the face, and then ignores it.

Wake up Doug.

Financial Terrorism? You Decide

nospam@example.com (Karl Denninger) — Sun, 24 Jan 2010 16:03:00 -0500

Watch this video clip first, and pay careful attention to the implied threat: do this or the market will blow up.

Let's cut the crap - this isn't the first time that this sort of raw threat has been made.

I will remind people that in September of 2008 when Bernanke and Henry Paulson demanded $700 billion for EESA/TARP, and threatened that "if this doesn't pass the market will blow up."

Well, The House initially refused to pass the bill, if you remember.

Do you remember what Ben Bernanke was doing behind the scenes at the time?

I'll show you - once again - as I pointed out at the time:

Remember this? $125 billion of "slosh", or excess liquidity, drained from the system in the four days from 9/19 - 9/24/2008.

To put this in perspective that was a drain of sixty-five percent of the total excess liquidity in the system - a "starvation diet" if you will - and that withdrawal was an intentional act!

The above is an irrefutable record of what The Fed actually did.

Remember that Bernanke's argument at the time was that the credit markets were suffering from a lack of liquidity. That is, there was no problem with firms actually being bankrupt, but they were illiquid.

If that's true why did Bernanke intentionally drain $125 billion from the system - two thirds of the market's total excess liquidity - instead of adding to it?

What did the market do after The Fed pulled $125 billion in system liquidity out over the space of four days?

Do you remember?

Does this prove that The Fed intentionally crashed the stock market? No, but it sure is a damning argument - statements of "do what we want or the market will crash" along with claims that "the system is illiquid" coupled with an intentional liquidity drain at the very same time, and leaves open the question as to whether The Fed provided "a damn big nudge" to "emphasize their point."

Remember the events surrounding this withdrawal of liquidity?

On September 7th, Treasury took over Fannie and Freddie.

On September 15th, Lehman failed.

On September 16th, The Fed loaned AIG $85 billion.

And on September 25th, the FDIC stepped in and effectively closed Washington Mutual.

Yet in the middle of this "liquidity crisis", while Ben Bernanke and Hank Paulson were corralling House and Senate leaders in the Capitol and demanded $700 billion in bailouts for Hank's unlimited and purely discretionary use, The Fed inexplicably drained $125 billion from the banking system.

And now they're at it again, with Gibbs issuing thinly-veiled threats that sound suspiciously like the very threats that were made in 2008 - either give the banksters effectively unlimited access to the taxpayer's jugular vein or the market will crash.

One has to wonder:

Did our economy fall down the stairs or was it pushed?

Three questions remain:

Is not a threat to destroy financial markets along with acting intentionally and directly opposite what you claim needs to happen an act of financial terrorism?

If it is an act of financial terrorism, why has it been ignored for more than a year instead of leading to a full investigation and hearing in front of a Grand Jury?

And finally, is the same thing happening - this time hidden because we can no longer see Federal Reserve liquidity actions in the clear light of day - once again, this time as a means of bludgeoning The Senate into reconfirming a man who is demonstrably unfit for his post?

Is the economy and our market being "pushed" once again?

Weekend Roundup 1/23

nospam@example.com (Karl Denninger) — Sat, 23 Jan 2010 14:32:00 -0500

Was that a little pre-shock tremor last week?

Let's review.....

Kennedy's former Senate seat - in a state that is so blue that you'd swear everyone is choking to death when you cross the state line, went to a Republican. A thirty-point swing in the polls in literally less than a month away from Democrats. Despite what the pundits have said this was not simply about health care. It was about general disaffection with where the country has gone and is headed.

Since March of last year the banks and stock market generally have rallied hard. But.....

The economy has not in fact improved. There are millions more out of work today than there were in March of 2009. There is scant little improvement in freight traffic. Sales tax and income tax numbers are below where they were last year at this time. This, of course, makes perfect sense - the unemployed pay few taxes.

The plates have been kept in the air only due to two things: (1) People not paying their mortgages for literally a year or more (and thus spending that money generally) and (2) massive transfer payments amounts to $500 billion a year from the government to the people - money that they borrowed, not taxed and collected.

You'd think with people not paying their mortgages the banks would be losing enormous amounts of money and all go under. The big banks haven't, but only because in March they got permission to lie about their "asset quality." This is a short-term game and relies on the cash flow being sufficient to (temporarily) cover up the truth. But the asset quality deterioration continues and the truly ugly reality isn't even found in the first mortgages - it is in the fact that all the home equity lines out there behind an underwater first mortgage that defaults are worth zero. These loans are concentrated in the "big banks" - and yet they are all carrying this paper at values assuming they'll be able to collect it. Best of luck boys.

In other words, the stock market rally has been about not improving economic prospects but rather utter BS, lies and scams. Let's look at some basic statistics:

15 stocks in the S&P 500 have a P/E over 100. 23 have a P/E over 60. 37 have a P/E over 40. 65 have a P/E over 30 and 152 have a P/E over 20. 220 - nearly half - have a P/E over 13, the historical long-term average. The latter statistic is trotted out from time to time to claim that the market as a whole isn't overvalued, but 125 stocks in the S&P 500 have a negative P/E - that is one quarter of the S&P 500 has negative earnings.
In the NDX (Nasdaq 100) believe it or not there are 13 stocks with a P/E over 40. But 39 have a P/E over 20 and 21, or 21%, have negative earnings.

People say we should ignore the past and focus on "predicted" earnings. But how accurate is that? Did those predictions correctly foretell the plunge in 2008 and early 2009? Nope. So why would you use them today, when they have a proven record of being wrong?

So how in the hell has the market rallied to the degree it has? Simple: The market is a read of "fear and greed", and as such as people perceived that thievery and scamming would continue to be profitable the market has reflected that expectation in price.

But things are changing. It has been reported that Wall Street bonuses will total some $145 billion. That's 1% of GDP - and is absolutely obscene. The people have figured out that this is really nothing more than Wall Street firms sucking the blood of the citizens, and while it would be ridiculous in a good year where everyone is flush with lots of spendable income coming on the back of a year where millions of Americans have lost their jobs, taxes are going up, cities and states are going bankrupt and the economy has been and is for crap it is the sort of thing that stirs thoughts of boiled rope, lampposts and resurrection of the guillotine among citizens.

The Senate went so far as to demand that the citizens bare their necks once again by filibustering a vote to end TARP immediately.

Democratic leadership opposed the amendment because they felt it would have handcuffed Treasury Secretary Timothy Geithner in his efforts to ensure the stability of the financial markets.

In other words, to make sure those $145 billion in bonuses could be paid - out of your pocket.

Of course this was just the last piece of idiocy. Fannie and Freddie had their losses transfered "in entirety" to the taxpayer on Christmas Eve - after the market closed and while nobody (they hoped) was watching.

The loss of the Massachusetts Senate seat may have rocked the foundation though. It sure led to President Obama deciding to roll out Paul Volcker and a proposal to end proprietary trading by banks - an abusive practice that has certainly played a big part of "heads I win ($145 billion), tails the taxpayer loses."

Is it enough? Hell no. Nor does it go to the core of the problem.

I know I keep hammering on this but its important - we cannot have a sound economy when the "earnings power" of Wall Street is entirely focused on stealing a kid's candy and sucking your blood - literally. Yet that's what it's been.

The entire premise of Wall Street (and banks generally) is to "expand credit." You hear it from Obama and you heard it from Reid yesterday in his begrudging "I might vote for Bernanke" claim:

Reid said that Bernanke "must redouble his efforts to ensure families can access the credit they need to buy or keep their home, send their children to college or start a small business."

There's the statement of the problem right "in your face."

Credit, folks, is just a fancy form of the old Wimpy character in the Popeye Cartoons: "I would gladly pay you Tuesday for a hamburger today."

The reason the market collapsed in the fall of 2008 and spring of 2009 is that the eating of hamburgers exceeded the ability to pay for them Tuesday.

This should not have happened and indeed it is Bernanke's job to guarantee that it does not, as mandated in The Federal Reserve Act (Title 12, Chapter 3, Sub1, Sec225a:)

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

In other words The Federal Reserve does not set interest rates. It is charged under the law with controlling credit growth such that all the hamburgers you eat today can be paid for Tuesday, on balance, so that production and thus the economy grows at a sustainable rate.

When The Fed violates this prescription, as it has for the last 30 years, you set the stage for a credit boom - and subsequent bust.

Yet to get the boom (and then bust) you need more.

See, unbridled credit growth isn't really under The Fed's control, at least not in the main. Sure, The Fed can irresponsibly grow credit aggregates entirely within the government sphere where there is no private market activity to stop it, but in the private markets this is not possible all on its own. That is, The Fed can stop the expansion of credit but it can't start the expansion; it has the ability only to place a cap on credit growth but not a floor.

Why?

Because in order to irresponsibly expand credit - that is, to grant credit to more and more people in larger and larger amounts, beyond that which is justified by actual economic expansion, someone has to get screwed.

That's an inescapable fact - growth of credit that is supportable by output is both reasonable and sound. Growth of credit beyond that rate can only occur if some of the people it is granted to can't pay. Given full disclosure of the quality of said credit it is unmarketable.

If you were to mandate that all lenders had to hold their loans on their balance sheets then lenders would be very unlikely to make an unsound loan, as they would have to eat it.

But securitization (and trading generally) of credit obligations (that is, debt instruments of all sorts) is not necessarily bad. Indeed, a debt (for the creditor) is an asset to the person who made the loan, so why shouldn't he or she be able to sell it like any other asset - a house, a car, a boat, a backhoe or a combine?

We recognize in the law that the sale of a car with known-bad brakes to someone without disclosing that fact is an act of fraud. It is illegal to do that, just as it is illegal to sell a car and intentionally lie about the number of miles it has been driven (by, for example, rolling back the odometer.) Such an act in business is widely recognized as fraudulent and exposes the person who does it to both civil lawsuits and criminal penalties.

This is where the fundamental disconnect between Wall Street (and the stock market over the last nine months) and reality on Main Street lies.

We have done nothing to dissuade fraud and lies in the credit markets - quite the contrary. We have further enabled those lies, and that is why the stock market has "recovered."

The dive during this last week - some 500 pts on the DOW and nearly 60 handles on the S&P - was not due to Mr. Brown's win, nor Obama's rant against the banks.

Rather, it happened because market participants are sensing a crack in the government's ability (but certainly not desire!) to keep the fraud going, to keep the lies from being exposed, and to keep the losses hidden where nobody can see or act on them.

That the truth will eventually come out, and the pyramid scheme that has "enabled" this unbridled credit growth to occur will ultimately collapse, is a certainty. We saw a piece of it in 2008 and 2009, but only a piece. By aborting the market's ability to price in that fraud and accurately represent earnings capacity as a function of actual economic activity as opposed to scams, obfuscation and lies we have done even more damage to our economic future.

President Obama owns all of that additional damage, as it all - every bit of it - happened on his watch. The possible embedding of $500 billion in structural deficits is a part of this - money we don't have and ultimately will not be able to borrow. The pressure from Geithner, Obama's employee, to demand "mark to fantasy" accounting, allowing banks to hold HELOCs and other loans at values assuming payment where such is very unlikely to occur. The pressure, temporarily sated, from the Wall Street banksters to take "just another drink" from your jugular vein, much like the vampires in Daybreakers, while those on the street are blithely unaware that in the "harvesting lab" all of their sources of blood are literally dying off.

There are many pundits who say that the sell-off this week was an "over-reaction" in that the big banks will find a way around Obama's plans, even if he manages to get them through Congress.

They're probably right on the latter, but like most who focus only on the immediate they're missing the forest for the trees.

Today's valuations in the market can only be sustained if you believe that credit can be expanded from today's approximately $53 trillion (total system-wide) to about $95 trillion over the next ten years. To believe this you must believe that either (1) there is more payment capacity for interest and principal in the economy than is being used - a preposterous notion when the entire collapse began due to people being unable to pay their debts or (2) that we can grow GDP by an average of 7% annually over the entire next decade without fail.

The last five decades of history says that #2 is flatly impossible.

If neither #1 or #2 can happen then what you saw this week is a warning, just as you saw warnings in the summer of 2006 and the early months of 2007. A sell-off triggered by a fleeting recognition that the values being expressed in the credit and stock markets do not reflect forward earnings capacity but rather the fact that Wimpy indeed cannot pay for his next hamburger come Tuesday.

We are only left to argue about when the market has night terrors of recognition and acts accordingly - not if.

Mish Misses The Mark (Glass-Steagall)

nospam@example.com (Karl Denninger) — Thu, 21 Jan 2010 09:56:00 -0500

In a rather interesting article this morning Mish attempts to argue that reinstating Glass-Steagall "wouldn't have solved anything."

The idea that Glass-Steagall would have done much, if anything to prevent this crisis is potty. Goldman Sachs, Bear Stearns, and Lehman would all have done what they did. Wells Fargo would have kept its pool of option arms, and the rest of the banks would have followed their lend to securitize model and the regional banks would still be losing their asses on silly commercial real estate deals.

Mish misses the point of Glass-Steagall.

It is not that Glass-Steagall would prevent people from acting fraudulently. It would not have done so.

Indeed, without prosecution of wrong-doing and strong anti-fraud statutes that are not only on the books but are actively enforced against everyone, including the "big society and political class", THERE IS NO BUSINESS STRUCTURE THAT PREVENTS THE SORT OF BS GAMES WE SAW DURING THE HOUSING BUBBLE.

However, Glass-Steagall's point is not to prevent fraud.

It is to prevent fraud, when and if it occurs, from bringing down the entire banking system and therefore removing the "you can't allow us to pay for our crimes in the free market or the world will end" argument from the banksters arsenal of arguments.

I believe it is unethical if not outright fraudulent to front run trades or to trade against advice given to clients. Units that offer advice must be physically separated, not logically separated from units that trade their own accounts. The only sure-fire way to make that happen is to physically breakup the companies.

All of this dark-pool stuff of sniffing out orders and front-running trades has to go as well.

Yep. I agree entirely.

But then Mish makes the "be careful what you wish for" argument:

Everyone wants more small business lending and less risk. Sorry folks, that is physically and logically impossible. Reducing reckless risk, especially risk born by others (taxpayers) is a good idea, but it's important to understand exactly what that will mean to earnings going forward.

Think of the affect lower share prices and reduced risk taking will have on pension plans and 401Ks. In the long run, less risk is a good thing, and I am in favor of it. I just doubt people are prepared for what it means.

This is a logically-false argument.

We have two options:

We can take our medicine. This means splitting up the commercial banking and investment functions into physically and legally separate firms so that never again will the investment activities of a firm be able to trash the depository function and thus expose the taxpayer to systemic collapse. We can prosecute prior fraud and make clear that any future fraud will also draw an immediate and vigorous criminal and civil fraud statute response. Yes, this will mean the equity market will adjust to actual, not falsely-inflated value on a forward basis and yes, this means we will trade lower - perhaps a lot lower. But it also means the market will be STABLE with prices based on actual earnings and profits, not fraudulent ponzi-style games.
We can continue to pretend that market prices don't matter, that you can securitize debt and yet end up with more yield in the product securities than existed in the original lending transactions (that is, that people not only work for free but work for a negative amount of money!) and that there will always be a greater sucker upon which to offload whatever we buy. In other words we can continue to do what we've done up until now - base our entire capital market structure on an ever-expanding pyramid of fraud and lies. We've done this twice in the last ten years and the consequence was two horrific market crashes in a decade's time, employment capacity utilization back to 1980s levels, a $1.6 trillion deficit as far as the eye can see and a market that has lost half or more of its value - on balance and with account for inflation - over that decade's time.

If we continue to choose path #2 there is a very real risk that the next crash will be too large for the government to be able to rescue or that the public will not permit another rescue irrespective of the government's desire to do so. That is, either the buyers of our debt may say "no mas!" or the people may say "screw you!" Indeed it should be assumed at this point that another bailout at any time in the next decade or more will be unable to be mounted, either due to public outrage, creditor revolt or both.

As such choice #2 is literally gambling with the future of the nation - and that, my friends, is a gamble we must not take.

Whether Goldman likes it or not.

To All US Citizens: Time to BOYCOTT China

nospam@example.com (Karl Denninger) — Mon, 18 Jan 2010 11:10:00 -0500

On the heels of Google's disclosure of a highly-sophisticated and coordinated hacking attack aimed at their infrastructure originating in China, Alibaba has turned up the heat on Yahoo.

Alibaba, an online commerce company in which Yahoo owns roughly a 40% stake, on Saturday slammed the Sunnyvale, Calif., company for its public support for Google in the search giant's conflict with the Chinese government over cyber attacks. Alibaba has told Yahoo that "Yahoo's statement that it is 'aligned' with the position Google took last week was reckless, given the lack of facts in evidence," Alibaba spokesman John Spelich said.

To Alibaba and China: BITE ME.

To the citizens of The United States: IT IS TIME TO BOYCOTT CHINA IN ALL OF ITS FORMS AND ALL OF ITS PRODUCTS.

Use this search to find the appropriate entries for your web servers and other devices to permanently block all Chinese IP addresses.

When you shop - look at the product first. If it says "Made in China" PUT IT BACK, DO NOT BUY IT, AND TELL THE MANAGER OR OWNER OF THE STORE WHY.

Look folks, we either stop this crap now or we will NEVER stop it.

China IS NOT OUR FRIEND.

They managed to buy, during Clinton's administration, highly restricted radar technology that has military uses. They used that technology to upgrade their nuclear ballistic arsenal. Instead of being able to hit within a mile or two they can now hit within a few dozens of feet. Guess where they have them pointed: AT YOU.

They infiltrated Clinton's campaign and illegally provided campaign funding (and got caught doing so.)

The Cox Report set forth very specific allegations related to the theft of US nuclear secrets, including warhead designs for essentially every advanced nuclear warhead we have ever built.

China's government either turns a blind eye toward or is intentionally complicit and participatory in campaigns designed to infiltrate the computer networks of both private businesses and government agencies within The United States and elsewhere. This is an ongoing, concerted, intentional effort. A huge percentage of the attempted hack attacks into my infrastructure for The Ticker and the machines at my headquarters location are sourced from Chinese IP addresses.

In fact I have had blocked, for an extended period of time, all non-web-based accesses to my infrastructure from Chinese IP blocks simply because I got tired of the nightly "security report" containing thousands, and in some cases tens of thousands, of instances of attempted hacking PER DAY coming from China.

The Federal Government clearly does not give a damn. It did not under Clinton, when I and others were reporting these assaults upon my ISP infrastructure, it did not under Bush when I saw them escalate dramatically against both commercial and government clients and it does not now under President Obama. Our federal government has become a Chinese lapdog when it comes to computer security and intentional, daily pervasive attempts to break into American computer networks - both privately owned and government-operated.

Our government seems to think that China is a "good friend." Indeed it it is - to multinational corporations that want effective slave labor available to produce cheap (and in some cases poisonous) garbage to be exported back to America. $30 DVD players are the benign items - cadmium-laced costume jewelry and lead-painted toys intended for our children are two of the more malignant.

Nor does it stop here. These Chinese firms literally steal anything they can get their hands on all with the active participation or at least silence by the Chinese Government. In the United States if you commit industrial espionage and steal the design for some gadget, then produce and sell it, you will be sued out of existence and/or prosecuted for the theft. In China such products are routinely sold and even exported without fear - The Chinese government literally REFUSES to enforce intellectual property rights.

That which our government will not do we must on our own initiative.

This means no more Chinese access to our networks.

It means no more purchases of Chinese goods.

It means no more Chinese anything.

And it means DEMANDING that the United States Treasury VOID all Chinese-held Treasury Debt as liquidated damages for the theft of our military secrets and civilian intellectual property.

From this American to China: SCREW YOU.

Here Come The Banking Shills

nospam@example.com (Karl Denninger) — Sat, 16 Jan 2010 14:47:00 -0500

You have to love the opinion piece posted a couple of days ago on The Wall Street Journal:

If you would know why bankers are enjoying a large and controversial deluge of annual bonuses, look no further than the monthly report of the New York State Comptroller's Office. The economy may be in the dumps, but Wall Street enjoyed record profits of $50 billion in the first nine months of last year—"nearly two and a half times the previous annual peak in 2000."

"Profitability," adds the state of New York, "has soared because revenues rose while the costs of doing business—particularly interest costs—declined" (in other words, thank you Federal Reserve).

Really? Are those actually record profits?

Holman Jenkins goes on to opine that all these bonuses are fine because they're just a cost of doing business (employment expense), these banksters are indeed highly mobile and will simply go work for someone else if they don't get this sort of pay, and with record profits should come record compensation.

Let's destroy the two central themes here one at a time.

First, exactly where will these banksters go if they don't get their "outsized compensation"? In case you haven't been paying attention the "official" unemployment rate is 10% but the actual percentage of working-age people that have a job has fallen to levels last seen in the early 1980s. Of those who are of working age and not in prison (that is, available to work) only a smidge over 58% are employed - a six percent drop, roughly, since the hayday in 2006.

That's roughly 98 million people who could be working but aren't, if you're counting. Beyond the "structurally unemployed" (that's a polite term for those who prefer to live on the dole and always have) we added some 25 million people to the workforce from 2000-2009 yet on net not one of them actually became employed, while in the last 18 months we fired some 9 million. A very large percentage of those fired, along with many who entered the workforce, are highly-skilled individuals. Even more highly-skilled individuals are literally pulling Espressos at Starbucks to keep from living in a refrigerator box. Exactly where would all these banksters go in this "mobile" workforce?

Answer: Nowhere. A job is better than no job, whether you get a $5 million bonus or not.

Second, let's talk about these "record profits." They're false.

But wait, you protest, it's right there on the quarterly report!

Oh really?

Let's do a bit of math. We'll call it "subtraction."

During the bubble years there were hundreds of billions of dollars in Home Equity lines written. 70% of them, by dollar volume, were written in Arizona, Nevada, California and Florida. A good number of these were securitized and sold off, but not all - there is a huge percentage of them sitting on these bank balance sheets.

Now here's the legal reality: They have zero recovery value in a foreclosure if the property is worth less than the first mortgage that they are behind.

This is one of the schemes that was promulgated by "mark to fantasy" accounting adopted in early 2009. In point of fact the market's price expectation (in the form of stock prices) was correct in March. These loans were worth nothing, they were being carried at dramatically above their actual market value, the homes involved would go into foreclosure and the recovery would be bupkis. Taken in this light virtually every large bank was (still, even after TARP!) insolvent, as the hit to the balance sheet from recognition of this fact was sufficient to force Tier 1 Common Equity and Tier 1 Capital below regulatory minimums.

This of course ignores all the really fun "assets", especially OptionARM and other similar loans. Many people have said that the record low interest rate environment will prevent much of the payment shock expected with resets, and they're right. But what it won't prevent is the payment shock that comes with a recast, and those start this year and continue for the next five, peaking in 2015 (OptionARMs typically recast at either 5 or 10 years post-issue.) None of these loans can be refinanced if the property is underwater and as a consequence the "recast date" is a hard wall that will force them to default.

Now let's ask the seminal question: What has factually changed about the character of these "assets" on bank balance sheets since March?

Here's the scorecard on the fundamentals behind the valuation of these "assets":

Home prices have continued to decline. That is, more homes today are worth less than their first mortgage than were in March of 2009.
The "skew", that is, where those declines have happened, continues to be centered in Arizona, Nevada, California and Florida, just as it was.
Mortgage performance, that is, the percentage of loans that are current, has continued to deteriorate. Indeed, it has deteriorated a lot since March of 2009.
The so-called "HAMP" program is a dismal failure, having led to fewer than 10% of the so-called "qualified trial mortgages" turning into permanent modifications. While everyone makes excuses nobody pays attention to the elephant in the room - the 2004, 2006 and 2007 warnings from the FBI, HUD and private credit analytics firms that about one in ten of these exotic loans were made to people who actually provided an accurate income. That is, nine in ten HAMP "modifications" are failing not because the program is defective in its design but because the person in the house could not ever and still cannot afford it!
The recast wall for OptionARMs is closer today than it was in March of 2009. A disproportionate percentage of HELOCs are behind these sort of tricky loans.
The labor rate (percent of employment-age people actually employed) has fallen 1.5% since March of 2009. That is, 3.6 million fewer Americans are working today than were in March - half of them by coming into the workforce anew, the other half as a consequence of losing jobs and dropping out of the workforce.

How is it possible for you to make "record profits" while your asset quality continues to deteriorate, payment performance continues to deteriorate, the ability of people to pay loans you gave them continues to deteriorate and the recovery value of the assets behind those loans continues to deteriorate?

You get government permission to lie about the value of what you own.

The problem with such a strategy is that it has a "use by" date, as cash flow always ultimately wins in such discussions.

It is in fact outrageous to claim to have made "record profits" by intentionally understating both fair value and reasonably-expected losses. Yet that is exactly what these institutions have done. Paying out "compensation" with what amounts to fake money that was in fact not earned (due to those hidden losses) is almost precisely what Madoff did with his clients - he claimed to have big "profits" that in fact never existed, all by falsely-inflating performance.

Such a strategy may work for a while, but it will not work forever. Eventually the underlying quality (or lack thereof) of the assets you hold pokes through and you're forced to recognize that fact. When, not if, that occurs these "earnings" will be shown to be false, yet the money will be gone.

I don't particularly care for the method President Obama has decided to approach this problem with. While it is broadly targeted at the right people it is both too small in dollar amount and fails to address the underlying issue, which is bogus valuations that continue to be claimed by these institutions and their refusal to come clean about the false profits being made not just now, but in the past.

However, the fact that these institutions could escape such a levy by breaking themselves up and thus not being subject to it is a positive. Broken up they would lose their seminal argument for why they should be "too big to fail" - that is, that their failure would destroy the economy.

I disagree that allowing all of these institutions to go bankrupt would have destroyed the economy or lending generally. It would have destroyed those who bought fraudulent securities and those who issued them, but that should have happened. The invisible hand of the market is the best medicine to stop fraud and bogus schemes, provided it is allowed to work.

But having made this decision back in March, we now need to both recover as much of the $10 trillion or more of damage these banksters did to the US economy as well as guaranteeing that it cannot happen again.

This fee is a start on the former goal.

The latter will come only when President Obama wakes from slumber, either on his own initiative as his popularity and re-election chances go down the toilet or when The American People force his hand, and we have The FBI directed to perform full forensic audits on each and every large financial institution that does business in The United States, with all instances of improper conduct thus discovered turned over to Grand Juries for consideration of indictment.

Until then we continue to walk in a living dreamworld, and one that can be punctured by global or US Economic events that are entirely beyond our ability to control.

The Financial Crisis Responsibility Fee

nospam@example.com (Karl Denninger) — Thu, 14 Jan 2010 12:49:00 -0500

I can't believe I'm going to actually agree with a new tax.

But I am.

Specifically, what The President proposed today:

WASHINGTON, DC- President Barack Obama will join his economic team today to propose a Financial Crisis Responsibility Fee to be imposed on the debt of the largest financial firms until the American people are fully compensated for the extraordinary assistance they provided to Wall Street.

The fee will be in place at least 10 years, but even longer if needed to pay back every penny of TARP. This will not be a cost borne by community banks or small firms; only the largest firms with more than $50 billion in assets will be affected. In fact, 60% of the revenue will come from the 10 largest financial firms.

While I'm sure the banksters will howl in protest and this has just turned into "The K-Street Full Employment Act of 2010" and the banksters will attempt to kill it, this proposal has my full support.

Here's why.

Critics want to have this both ways. They both argue that "the bailout (TARP/EESA) was necessary to save the financial system" and then "but they paid it all back."

You can't have this both ways.

Either the money was necessary to save the financial system in which case these firms would have all failed without it, or the claims that it was necessary are a lie.

If the claim is a lie then everyone involved in promulgating that lie need to go to prison right now for stealing form The American Taxpayer - and it wasn't a small theft either. Not only that but the drama involved in our Capitol clearly incited fear and panic in the financial markets, which I can easily argue would, if undertaken under false premise, was an act of domestic terrorism. So before you argue that this is "unfair", make sure you're prepared to send everyone involved in that charade straight to prison for making terroristic threats against the United States.

Notice, however, that none of these banks spoke up at the time saying they didn't need the money or legislation.

There was no public appearance by Jamie Dimon, Lloyd Blankfein or any of these other banksters at the time lobbying AGAINST passage of EESA/TARP - publicly or otherwise.

It is ridiculously dishonest to now claim that "some banks didn't need it" or that "we didn't really need to do that", especially when it comes to ToutTV, which as all over the necessity of this program and still is.

Both previous and current administrations made the same argument at the time and still are.

So if we accept that absent this "assistance" the entire financial system and all of these banks would have collapsed, then fining them after the fact to compensate us for the damage that was done to our economy and employment picture as a direct and proximate cause of their unreasonable risk-taking is not only reasonable, what has been proposed doesn't go anywhere near far enough!

Tax policy is a poor way to shape public action but as a punitive means of clawing back the illicit actions that have harmed this nation it is both appropriate and necessary. The banksters who engaged in these transactions knew or should have known at the time they were structuring all these products that the borrowers couldn't pay. They had to know, given the publication of studies by HUD and others in 2006 and 2007, that these securities were packed full of fraudulent loans, yet they not only didn't stop it they didn't alert their clients to this fact in their offering circulars.

In point of fact the damage done to this nation and her citizens by these illicit actions mounts into the trillions of dollars, not tens of billions, and the people of this nation are due that money - all of it - even though I'm well-aware that we'll never be adequately compensated for what these people have done and the harm inflicted on our nation and indeed the world.

As such I rise in full support of this proposal, and in fact will call it what it is: a good start, but by no means sufficient.

Truth Peeks Out From Under The Blanket

nospam@example.com (Karl Denninger) — Wed, 13 Jan 2010 13:13:00 -0500

Gee, you think?

Jan. 13 (Bloomberg) -- Goldman Sachs Group Inc. Chief Executive Officer Lloyd Blankfein testified today that he was never asked to accept a discount on investment contracts his firm had with American International Group Inc.

....

The New York Fed said it had to make the payments after banks refused to accept so-called haircuts, according to a November audit from Neil Barofsky, the special inspector of the U.S. Troubled Asset Relief Program.

Had to eh? And they had to.... why?

Banks refused to take less? Lloyd testified this morning that Goldman was never asked!

How can you "refuse" something you're not asked to do?

Someone's full of it here.

The people have had it with the lies, theft and fraud. Lloyd also said in testimony that Goldman "might have participated in the froth in MBS", implying of course that it was "inadvertent."

Well, I disagree that it was "inadvertent."

The question is not one of whether someone intentionally, at the outset, set out to screw people. It is whether banks and others intentionally and willfully derogated credit standards and lending requirements and then failed to disclose in a full and fair manner to the buyers of the securities what they had done, what they were omitting and what they knew - and when they knew it.

Is that illegal? Whether it is or not it damn well should be to push securities to investors while in constructive or actual possession of knowledge that you're intentionally omitting - and that would impact their value.

As early as the spring of 2007 this information was in the press - that "stated income" loans were predominantly fraudulent. That is, the majority of them were made with the borrower's income not matching what they "stated", with first warnings appearing in mainstream print media in 2006!

One lender recently compared 100 stated-income loans with the borrowers' tax returns and found that only 10 of the borrowers were telling the truth about their wages, according to Mortgage Asset Research Institute, a division of data firm ChoicePoint Inc.

Sixty of the borrowers had exaggerated their incomes by more than 50%, according to the institute, which didn't identify the lender. (September 29th, 2006)

For two years longer the band played on, the banksters and government officials, including The NY Fed and Federal Reserve itself ignored the issue, and took no enforcement action of any material sort.

Doug Elliott has it exactly right:

“The politics on this is really quite easy,” said Doug Elliott, a fellow at the Brookings Institution in Washington and a former managing director at JPMorgan Chase & Co. “The public would be supportive of anything up to shooting and burning the bankers.”

Damn straight the public would and should. We put Tim McVeigh to death for blowing up a building and killing 168 people while shattering hundreds of lives. These banksters and their accomplices have destroyed the economic lives and futures of tens of millions of Americans and yet they are all, to date, walking free among us and enjoying billions in bonuses!

I'll settle for hard prison time and the break-up of ALL of these institutions given the admitted and indisputable facts:

Henry Paulson, before becoming Treasury Secretary and while running Goldman Sachs, lobbied for and received a removal of the former 14:1 leverage limit for investment banks in 2004. Every firm that subsequently failed, including Lehman and Bear (which were previously subject to this limit) racked up more than double that amount of leverage in less than the subsequent four years.
We had hard research as early as 2006 that stated income and other "alternative" financing programs were rife with fraud - that in fact half or more of all mortgages under these programs were being made to people who overstated their incomes by 50% or more. The banks knew it, the ratings agencies knew it and the government knew it. Yet none of these institutions applied a proper haircut to borrower incomes when they ran their rating and performance models. This was not an accident - it was an intentional act as that knowledge was in the marketplace!
Some investment banks not only failed to disclose this clearly in their offering prospectuses they pretty clearly knew it and were making trading decisions based on it, given that they were shorting the very instruments they were assembling and selling to customers, representing to those customers that these were "good product." Arguments that this was "simple hedging" flies in the face of the fact that one who is actually distributing product (as opposed to taking a position for or against that product) has no real reason to be long or short, do they? Indeed, find me just one offering prospectus from 2006 or 2007 that disclosed that these studies had shown that half or more of the "stated income" loans in these securities were made to someone who had intentionally overstated their income by 50% or more. I've not been able to find even one offering prospectus in which this was properly disclosed.
These investment banks, in addition to selling these securities to investors around the world, also marketed these products to PENSION AND MUTUAL FUNDS that Americans rely on for their retirement. These Americans were SEVERELY damaged and will NEVER recover the value of these so-called "securities" that were in many cases worth essentially NOTHING.
The above fraud in the lending and securitization marketplace harmed most Americans by creating false upward price pressure on every home in America. Each and every American who did not lie during the 2003-2007 period when they purchased a home was harmed by overpaying for a house. Each and every American who was falsely led to believe that their home value had in fact appreciated when it had not, and acted on that belief (taking a HELOC or refinancing) and now finds themselves underwater, was harmed. And each and every American who was unable to buy a home due to insane price "appreciation" that was in fact false was harmed. These harms are real, they are material, they can be reduced to a money amount and in aggregate amount to trillions of dollars.
Americans were then further harmed by the bailouts and now-outrageous budget deficits that have come from the process of attempting to unwind this mess. The job loss that has resulted has resulted in not nine million Americans being jobless but 34 million, or more than one in ten of all Americans including those not in the workforce, and more than sixteen percent of all working-age non-institutional persons. This is on top of the "residual" level of unemployment that tends to be impossible to eradicate (about 5%) which means twenty one percent of all working-age adults is currently without a job, an increase of some 300% over the last 18 months.

Americans are damn tired of the lies, the misdirection and the utter failure of The Obama Administration to do what they promised to do - that is, to not be an administration catering to the banksters.

"I did not run for office to be helping out a bunch of fat cat bankers on Wall Street," Mr. Obama said in an interview on CBS's "60 Minutes" program on Sunday.

YOU ARE A LIAR MR. PRESIDENT.

You will, as of January 20th, have had one full year to start issuing indictments for the clearly-fraudulent practices that harmed virtually every American and are at the root of the economic mess we are in today.

YOU HAVE REFUSED despite the record and facts being clear and indisputable. The above points are not conjecture, supposition or belief - they are all hard facts.

The harm done to ordinary Americans can be measured in the trillions of dollars and yet you, Mr. President, along with Congress, simply do not give a damn.

If you will not act then we the people must.

We have lawful actions available to us, including organizing mass-removals of funds from the "too big to fail" banks by ALL honest Americans and national strikes.

THE FIRST we're already doing. Seen http://moveyourmoney.info yet? Some of the biggest Democratic supporters out there ARE DIRECTLY AND PERSONALLY BEHIND THIS EXPRESSION OF DISPLEASURE WITH YOUR ADMINISTRATION.

National strikes are the next logical thing for we the people to start organizing. Hit the government where it hurts - in the tax base. Those who work less pay fewer taxes and that's all entirely within the law. We don't have to work as hard and as long as we can.

We can also decide we won't pay debts that are owed these banks, declaring that we'll recover our part of the trillions of dollars these institutions stole unilaterally through offsets. Done en-masse there isn't a thing the banks and credit agencies could do about it, and if done in sufficient numbers as an act of mass protest FICO scores would become meaningless as well.

And finally, we have a say on this outrage come November, and you can bet we're going to exercise it in earnest unless we see action, right here and now.

As things stand today I assert that your party, who you are the head of, spoke nothing more than campaign LIES intended to convince people to vote for not Democrats but KLEPTOCRATS of which you are both The Commander and Thief in Chief.

PIMCO Calls For A Hyperinflationary Collapse In Japan

nospam@example.com (Karl Denninger) — Sun, 10 Jan 2010 22:41:00 -0500

I never thought I'd see the day....

An economy enters a liquidity trap when the monetary policy rate is pinned against zero, yet aggregate demand consistently falls short of aggregate supply potential.

Correct, as far as it goes.

And Japan is indeed an exception, because the central bank uniquely has the ability to foster rising inflationary expectations, lower real long-term interest rates, and a lower real exchange value for the yen, all keys to breaking out of her liquidity trap.

The latter ultimately can lead to currency destruction. This, of course (the currency) is all the central bank has as its stock in trade. Should it destroy it, the Central Bank will then have nothing. It will in effect cease to exist as its only item of value will have become extinct.

If the BoJ needs academic footing to do what needs to be done, it could well follow then-Fed Governor Bernanke’s 2003 suggestion: Rather than targeting the inflation rate, the BoJ could target restoring the pre-deflation price level, meaning that deflationary sins are not forgiven. This way, Mr. Bernanke argued, the public would view reflationary increases in the BoJ’s balance sheet and the money stock as permanent, rather than something to be “taken back” at the earliest orthodox opportunity.

The problem with such a move is that while you can achieve it in terms of nominal prices in the marketplace you cannot force through that same devaluation into wages.

The consequence of such a policy thus has the potential to be truly catastrophic for the citizens of the nation.

Buy unlimited amounts of the long-dated Japanese Government Bonds (JGBs) to pull down nominal yields, with an accord with the fiscal authority to absorb any future losses on JGBs, once reflationary policy has borne its fruits, generating a bear market in JGBs.

Working with the Ministry of Finance, sell unlimited amounts of Yen against other developed countries’ currencies, printing the necessary Yen.

In other words, devalue the currency to whatever extent is necessary to cause prices to rise.

The problem with liquidity traps is that they are born out of a deficit in the ability to borrow. That is, those who wish to borrow are unworthy of further extension of credit, while those who are worthy are unwilling to borrow.

This causes the excess money supply to not be circulated in the form of credit (via the reserve ratio) but rather to sit and do nothing of value.

Liquidity traps occur when Governments and Central Banks together encourage speculative asset bubbles instead of productive investment through willful blindness toward outright fraud in various lending activities in conjunction with "easy money" policies. Over time this consumes the margin between the outstanding borrowed amount and the borrowing capacity in the economy. When that capacity is exceeded the credit bubble collapses and no attempt to reinflate it will work, as the capacity and willingness to carry more debt does not exist.

Note that the worthy cannot be convinced to borrow simply by devaluation of the currency. Indeed, borrowing only looks intelligent under such a circumstance if you are convinced that the economy will recover with zeal and thus productive investment is warranted. (Borrowing to speculate will occur whether the forward view for the economy is good or poor - there's always somewhere to speculate if you are so inclined, especially when the borrowing rate is at or near zero!)

But when you commit to the raw printing of money borrowing for productive investment is an idiotic premise as each of your dollars (or yen in this case) that you EARN with that investment will be worth less than the yen before! You thus must outrun not only the borrowing cost but also the intentional devaluation of your earnings with that investment, and this, when faced with a government apparatus that has explicitly announced that it will not stop until it achieves some goal you have no control over or input toward, is a dangerous game indeed.

Increasing the amount of base money in circulation via direct printing through the wanton devaluation of the currency may cause prices to eventually rise but that rise in prices, due to slippage in the economy, results in a deficit in incomes even in the best of circumstances.

America discovered this in the 1970s - we suffered high price inflation yet even with union representation that has since been destroyed nearly all Americans saw their real purchasing power decimated during that decade as wages lagged woefully behind prices.

Where there is a structural problem with the employment base (such as exists in Japan and, to a lesser but growing degree in the United States) such a policy "wins" in the technical sense but bankrupts huge percentages of the population at the same time, exactly as it did in Weimar Germany. In the extreme case it is likely to bankrupt nearly everyone and can even lead to the violent overthrow of a government or rise of a dictator, as occurred with Adolph Hitler.

Such a policy as Paul McCulley and Tomoya Masanao have suggested quickly becomes self-reinforcing as the printed money forces down real wages in purchasing power terms, and thus the government is called upon to manufacture ever-larger amounts of "stimulus" and largess to be distributed to the population in the form of entitlements and social spending of all sorts. This too is a positive feedback loop that grows incessantly as a consequence, once again, of slippage in the transmission mechanisms. If the government does not realize the error in this path - that wages cannot keep pace with the devaluation since the transmission mechanisms are never 100% efficient - it will literally print to destruction.

PIMCO's Bill Gross in fact just identified this same feedback loop in the United States, although he doesn't realize it. In point of fact fully $500 billion of the deficit from last year was spent directly and indirectly on handouts to an increasingly unemployed population, thereby increasing the incentives to be unemployed as opposed to seeking employment. This in turn is reflected in the participation rate which has fallen in this recession thus far to levels last seen in 1983, destroying twenty five years of labor force progress in less than 18 months!

This in turn has raised the specter that the $500 billion in outlays via these "handouts" has become structural, and thus will mutate into a similar demand that The Fed either "print more or we deflate hard", exactly as happened in Japan.

The problem is that eventually you deflate anyway as it is not possible to couple your reflationary attempt with any sort of parity (or better) into personal income. The ultimate outcome is thus certain - the economy will deflate anyway but you will destroy the purchasing power of every saver in the nation along with everyone's ability to earn a living first!

When nobody is left with a job due to the destruction of purchasing power up the wage and income scale asset prices in real terms collapse no matter how much money you print!

As a consequence all intentionally inflationary acts by a central bank deprecate the general public's savings AND purchasing power in real terms. This is an intentional criminal act for which the persons responsible deserve to be held to account. History says that if the politicians and Central Bankers do not stop this self-destructive process before it reaches a critical self-reinforcing level the certain means by which they will be held to account is through the self-immolation of the political system in the nation involved. Most of the time this is followed by the rise of a tyrannical government that immediately executes both the government officials and Central Bankers who were responsible.

Paul Volcker recognized this in the 1970s and did what was necessary to stop the cycle before it resulted in the destruction of our government. We now have a cadre of limp-wristed Central Bankers who believe they can ignore the lessons of history, including Zimbabwe, Argentina and Weimar Germany.

THEY ARE WRONG.

There is only one way out of a liquidity trap that does not involve impoverishing everyone: you force those who are overlevered, no matter who they are, through bankruptcy and by doing so you default the insoluble debt, removing it from the system.

This often causes severe asset price deflation as assets are forced into liquidation, but it restores balance between asset prices and earnings while at the same time allowing those who have been prudent and did not take on excessive leverage to survive and even prosper during the necessary period of adjustment.

While I would hate to see Japan follow the idiotic prescription put forth by Mr. McCully and detonate itself, it is preferable that it happen there to here in The United States.

I therefore suggest that Japan's central Bank immediately adopt PIMCO's suggestions, in the hope that we will be able to learn by watching them implode their currency and nation, and through observance of the idiocy of this path avoid the same fate ourselves.

Godspeed to the BoJ.

Hint To Other Nations: Here's The Bill

nospam@example.com (Karl Denninger) — Tue, 05 Jan 2010 12:01:00 -0500

For your coddling of the banker cabal, that is.

Yes, that's my view. This sort of bluster and bullshit must not stand:

Dutch Finance Minister Wouter Bos would not be drawn into speculation on steps against Iceland. "But this can't go on forever. We want our money back. We negotiated reasonably."

Mr. Bos, go perform an indecent act on yourself.

You, along with the rest of the "western world", were complicit in and willing partners with the criminal banking cabal that ripped off the entire world with their worthless securities.

You "negotiated" for the right to steal even more after you failed to lock up the banksters for their criminal conduct - for intentional concealment and fraud in their "marketing" of these securities to investors worldwide.

You, just as with those here in Washington DC, were fully complicit in the looting of the public that took place over the last decade and more.

YOUR GOVERNMENT has allowed institutions in your nation (and elsewhere) to claim that "debt is output" and that speculation constitutes GDP. That's a willful, knowing lie.

Britain is also weighing in with the following threat:

Myners (the British Financial Services Minister) told the BBC that if Iceland voted against the deal, it would cut itself off from the global financial system and from International Monetary Fund aid for its economy, one of the worst hit by the world bank crisis.

'The Icelandic people, if they were to reach that conclusion, would effectively be saying that Iceland does not want to be part of the international financial system, that Iceland doesn't want to have access to multi-national, national and bilateral funding and doesn't want to be regarded as a safe counter-party with whom to do business,' Myners said.

Mr. Myners, with all due respect (that is, none), may you be fornicated by a stallion.

"The City" has for literal hundreds of years been the hotbed of bankster corruption, greed and fraud. Your nation is on record (in The Congressional Record no less!) as having sent bankster "representatives" over to this country shortly after it was formed for the explicit purpose of bribing our Congress into being recaptured after you lost the Revolutionary War!

I, for one, am tired of this game of "captured government" and it appears so is Iceland and its people.

It's about damn time.

You and your ilk had every ability to stop the fraud and looting over the last several decades. You could have prevented the blowing of your own property bubble and destruction of your federal budget, along with the insane expansion of leverage and "yield seeking" through fraudulent misrepresentation of risk and leverage but you didn't do so. Instead you, like the so-called "government regulators" in The United States, knelt before the banking cartels and performed obscene acts so frequently that you wore out sets of kneepads at a rate that kept Home Depot's profit margins at a record during the decade of the 2000s.

Now that the bubble has burst you're whining that you're going to have to eat the product of your own cooking and willful blindness.

To that I say: Tough crap.

Start locking up the jackasses who did this to the global economy instead of kneeling before Zod for yet more obscenities. You know who they are. Just walk down any of your much-vaunted "streets" in "The City" and where you see a $5,000 suit apply a pair of handcuffs.

If you won't and don't I predict that it will not be long before the reaction of the Icelandic people spreads - including to the UK.

Whether the people of your country will give you the opportunity to do the right thing when, not if that sentiment spreads is something you may wish to ponder.

A Cautionary Tale

nospam@example.com (Karl Denninger) — Tue, 05 Jan 2010 08:39:00 -0500

When in the course of human events......

So began a document written over 200 years ago.

But for a very long time, before there were firearms in the hands of the people, there were pitchforks and.....

Yes, that would be torches.

But that is not 200 years ago, or 400, or 1,000.

It is today.

In Iceland.

A land where a handful of banksters robbed the nation and looted its Treasury, then demanded that the public accept paying for the consequences.

The people have risen and declared that these are the acts of a criminal gang. That the actions that led to this distress were not mistakes, they were instead unindicted and unpunished felonies. That the people were unwilling and unknowing dupes, not willing participants with equal culpability.

And finally, that they will not pay so the criminal cabal - the international bankster fraternity - will be protected and made whole.

Iceland's President has said "no":

“The cornerstone of Iceland’s constitution is that the nation is the highest judge for the validity of law,” Grimsson told reporters at his residence outside the capital Reykjavik today.

Grimsson vetoed the so-called Icesave accord after more than 60,000 of Iceland’s 320,000 inhabitants signed a petition urging him to reject the legislation. His decision means lawmakers must either drop the bill or put the matter to a referendum.

Does anyone know what the laws are governing immigration - to Iceland?

I'm only half-joking.

This is the first President who has acted as a President. Who has recognized, understood and acted in accordance with the will of the people.

70% of the population appear to oppose bailing out the criminal cabal.

Contrast this with the EESA/TARP legislation.

By a margin of more than 100:1 and in some districts a margin reported as high as 300:1 The American People called, faxed and emailed their Representatives and Senators, along with the White House, to tell them NOT TO BAIL OUT THE CRIMINAL BANKING CABAL.

Our Congress and President did so anyway.

In Iceland we have seen proof that a strong display of the good old-fashioned torch - with the implied threat of the pitchfork being next - was sufficient for the government to recognize that:

That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.

Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn that mankind are more disposed to suffer, while evils are sufferable than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.

I am convinced that our nation will not stop being looted by this very same criminal cabal until The People display the torch and reiterate the foundational principal of this Republic - that we, the people, are stating our intention of revoking The Government's right to exist should it continue to act at the behest of a criminal cabal hellbent and determined on looting every member of society along with the public Treasury.

The choice is yours America.

You have seen today that forceful yet peaceful demonstration - a clear and unmistakable statement that the principles that underlay The Declaration of Independence remain in full force and effect, and that we, the people are both willing and prepared to enforce them if it becomes necessary - still works.

That you, not the den of vipers, control the ultimate path of legislation in all civilized nations.

When will you, America, be willing to display your torch?

Ah, It's About Time (CDO Lawsuits)

nospam@example.com (Karl Denninger) — Wed, 30 Dec 2009 09:04:00 -0500

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.

Finally: Mainstream Press (Intentional Defaults)

nospam@example.com (Karl Denninger) — Fri, 25 Dec 2009 14:53:00 -0500

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:

Your legal obligations are within the four corners of the document(s) you sign. No more, no less.
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.
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.

Thou Shalt Steal

nospam@example.com (Karl Denninger) — Tue, 22 Dec 2009 20:56:00 -0500

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.

ECB Dissembles And Equivocates: Greece

nospam@example.com (Karl Denninger) — Mon, 21 Dec 2009 11:03:00 -0500

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.

Greedspan: Stick A Sock In It

nospam@example.com (Karl Denninger) — Fri, 18 Dec 2009 09:13:00 -0500

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.

The Last Word On Strategic Defaults

nospam@example.com (Karl Denninger) — Thu, 17 Dec 2009 12:48:00 -0500

I'm tired of the repeated bull-crap from the media and various carny barkers about "moral obligations" to meet your payments on underwater property.

Why is it that you have a moral or ethical obligation to BANKS to do this, when THOSE VERY SAME DAMN BANKS ARE WALKING AWAY IN THE SAME FASHION I ADVOCATE?

Dec. 17 (Bloomberg) -- Morgan Stanley, the securities firm that spent more than $8 billion on commercial property in 2007, plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.

The bank has been negotiating an “orderly transfer” of the towers since earlier this year, Alyson Barnes, a Morgan Stanley spokeswoman, said yesterday in a telephone interview. AREA Property Partners will take over the buildings. Barnes declined to say when the transfer will occur.

“This isn’t a default or foreclosure situation,” Barnes said. “We are going to give them the properties to get out of the loan obligation.”

Right.

Exactly as you do when you strategically default on your mortgage, giving the property back to the bank to get out of your loan obligation.

Why is Morgan Stanley doing this?

The Morgan Stanley buildings may have lost as much as 50 percent since the purchase, he estimated.

As a consequence of being "upside down" they are walking away.

This isn't the first one Morgan Stanley has walked off on either:

Morgan Stanley last month agreed to hand over Crescent to Barclays, ending the firm’s obligation on a $2 billion loan after taking almost $1 billion in losses.

When Morgan Stanley acquired it, Crescent owned 54 office buildings in cities including Dallas, Houston, Denver, Miami and Las Vegas. It also owned the Canyon Ranch spa and resort, residential developments in Scottsdale, Arizona; Vail Valley, Colorado; and Lake Tahoe, California.

Got it?

BANKS - the very same BANKS that people claim you have a MORAL AND ETHICAL OBLIGATION TO PAY EVEN IF YOU ARE UPSIDE DOWN - are walking away (by "negotiation" - as in "do it or we'll default and you'll get even less!") from properties EVEN WHILE THE CARNIVAL BARKERS IN THE PRESS ARGUE IT IS IMMORAL FOR YOU TO DO SO.

In a word: BULLSHIT.

This is exactly the same thing - a "strategic default", which people define as:

"strategic default," walking away from their mortgages not out of necessity but because they believe it is in their best financial interests.

Morgan Stanley CAN pay, they are simply choosing not to, because the property has fallen in value.

This is exactly identical to you choosing not to pay because YOUR HOUSE has fallen in value.

George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay -- and weren't deceived by the lender about the nature of the loan -- have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.

Really?

I called Mr. Brenkert and spoke with him for a while this afternoon, and pointed out the above - that the asymmetry of position here is untenable and is in fact a big part of why we're in this mess.

Let's be clear: Those arguing for this from the banking and regulatory industry know how you stop people from "Strategically Defaulting" - don't give people loans that make such an option attractive!

If we had only 20% down 30 year fully-amortizing fixed-rate loans in the mortgage business nobody in their right mind would strategically default, because they would lose their 20% and even if prices declined they would likely (with amortization) be either ahead or darn close to it - that is they'd lose actual money.

But on the business side of things we allow companies to set up separate LLCs and then trade on the "parent" credit even though there is no recourse to the parent. This allows firms like Morgan (or the builder down here near me that has a bunch of these shell LLCs) to build and buy huge amounts of real estate - yet when something goes wrong they have tremendous leverage on a short sale, put-back or simple walk-off: if the lender doesn't like it they'll bankrupt the "container" LLC and the lender will get nothing.

Consumers, of course, can't do that. Try to set up a LLC and then use it as a vehicle to buy a house without a personal guarantee associated with the loan.

Forget it.

Try to get a small business loan with only the business as the collateral - no personal guarantee.

Forget it.

It is therefore my contention - and on this point Mr. Brenkert agreed - that the rules must be consistent for everyone, and if big business can strategically default on their obligations for profit (rather than for hardship) then consumers should be able to do so as well.

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.

Citibank Dissembling Again: Foreclosures

nospam@example.com (Karl Denninger) — Thu, 17 Dec 2009 08:37:00 -0500

This sort of nonsense is exactly the kind of accounting game that I've been yelling about for two years.... and as is my usual practice, I'll translate it into English for you in my usual sarcastic fashion (my view of it in italics, of course, with the original struck out):

NEW YORK (TheStreet) -- Citigroup said Thursday it plans to suspend foreclosures for 30 days for homeowners with Citigroup-owned mortgages.

Under the program, which begins Friday, Citigroup will halt all foreclosure sales on first mortgage accounts nationwide through Jan. 17. The bank also will ~~cease evictions~~ wait until the weather is even colder to throw people into the street in their underwear.

Citigroup's program affects only those loans owned by the bank, about 20% of the company's $746 billion mortgage servicing and lending portfolio, Citigroup said.

Citigroup said the suspension will affect about 2,000 borrowers scheduled for foreclosure and another 2,000 that were to receive foreclosure notifications in the next 30 days.

"~~We hope that with this suspension we can make the holidays a little less stressful for our customers who are going through a very difficult time~~ We are doing this so as to avoid having to recognize the loss on properties that are deeply underwater, thereby cooking our books until the quarter is reported so we don't have to declare insolvency," said Sanjiv Das, president and CEO of Citigroup's mortgage division, in a statement.

There - fixed it for 'ya.

Europe: An Impending Disaster

nospam@example.com (Karl Denninger) — Wed, 16 Dec 2009 20:50:00 -0500

I have long maintained that the EU Zone is an absolute train wreck - that their banks have less transparency and more leverage than ours, and have recognized less of their total losses.

As such they are literally dancing with jugs of nitroglycerine.

Well, now Bloomberg pipes up with this:

Dec. 17 (Bloomberg) -- European Central Bank officials are moving closer to forcing banks to provide more information about the collateral they give the ECB in return for loans.

What?

You mean the ECB doesn't have full information about the paper they took in as collateral for loans? What could they possibly want to know?

Under the terms of the collateral consultation, officials want banks to provide information about individual loans such as the value of the property backing a mortgage, details on cash flow and whether the borrower is in arrears, the people said.

WHAT?!

You have to be kidding me. The ECB is holding paper as collateral where they don't even know if the borrower is making the payments - that is, whether THE LOAN HAS DEFAULTED OR NOT?

The ECB has already tightened the rules for asset-backed securities it accepts as the central bank moves toward unwinding its emergency liquidity measures. The ECB said Nov. 20 it wants to ensure “high credit standards” are met and aims to restore “the proper functioning of the ABS market.”

Like hell.

I warned you all several times about this crap. Now it's leaking into the mainstream media...... which means that beyond the walls of the ECB it is now common knowledge.

How long before you see this?

PS: There's more where this Ticker came from - this one is a tease for tomorrow..... To those who said the Euro Zone would be ok, I have only one phrase for you: "I told you so!"

UAE Joins Bailout World (Dubai)

nospam@example.com (Karl Denninger) — Mon, 14 Dec 2009 08:33:00 -0500

Or did they? It sure sounds that way....

First, the Government of Abu Dhabi and the UAE Central Bank have agreed to provide important support.

Specifically, the Government of Abu Dhabi has agreed to fund $10 billion to the Dubai Financial Support Fund that will be used to satisfy a series of upcoming obligations on Dubai World.

You'll bail out the immediate maturing bond (you can call it a "sukuk" if you want; I call it a dodge to "comply" through fraudulent means a claimed absolute ban on the charging of interest, but then again, I tend to view anyone who creates artifices like "sukuk" as a fraudster.)

As a first action for the new fund, the Government of Dubai has authorized $4.1 billion to be used to pay the sukuk obligations that are due today. The remaining funds would also provide for interest expenses and company working capital through April 30, 2010 – conditioned on the company being successful in negotiating a standstill as previously announced.

In addition, the Government of Dubai is particularly focused on addressing the concerns of Dubai World trade creditors within the Emirate of Dubai. To help address these concerns, today the Government of Dubai is announcing that the remainder of the funds provided will be used for the satisfaction of obligations to existing trade creditors and contractors. Discussions with affected contractors will begin in short order.

Discussions eh? Uh, what's there to discuss? You have an invoice for completed work, why not just pay it? Why do I get the feeling that the "discussion" will be over what percentage of those invoices you will pay?

Second, read that bolded part. If you're a creditor inside Dubai you will obtain protection in some form. If you're a Japanese, European or American contractor you're not inside Dubai and from the black-letter of this press release you are entitled to and will receive exactly nothing.

Next, the central bank is also prepared to provide support to local UAE banks.

But only local UAE banks. Everyone else can go stuff, right? Since most of the lending wasn't by UAE banks.....

Finally, today the Government of Dubai will announce a comprehensive reorganization law, a framework that is based upon internationally accepted standards for transparency and creditor protection. This law will be available should Dubai World and its subsidiaries be unable to achieve an acceptable restructuring of its remaining obligations.

Oh really? Is the King's Land going to be subject to seizure? I doubt it.

Let's face the facts about Dubai - you've run an effective slave labor camp over there for the last decade - a practice that supposedly disappeared worldwide in the 1800s.

But in point of fact, effective human trafficking and slavery have not ended. It was, however, the necessary condition for "Dubai World" and its similar adjuncts to be a viable economic entity, given that Dubai has zippo for natural resources (unless you count the raw material for high-quality glass to be a natural resource, although it is not exactly in short supply - or expensive) and was entirely reliant on conspicuous consumption of oil revenue - which incidentally also seems to all belong to what amounts to absolute monarchies and those who they have enabled - for its continued "prosperity."

We are here today to reassure investors, financial and trade creditors, employees, and our citizens that our government will act at all times in accordance with market principles and internationally accepted business practices. Dubai is, and will continue to be, a strong and vibrant global financial center. Our best days are yet to come.

Do those "best days" continue to include dumping raw sewage - complete with the condoms used by your Islamic friends who use Dubai as a place where they can ignore Islamic Law (provided you're one of the privileged rich) a few hundred yards from your "pristine" beaches?

Go have another hit off your hookah Sheikh. Your vision of a "global financial center" for those with too much money and too few brain cells will eventually be reclaimed by the desert, as it should be.

I continue to believe that the "infidels" will get hosed, and as noted above, there are plenty of weasel-words in your "statement" to keep anyone from claiming you lied through you teeth when the unilateral imposition of haircuts - against all but UAE-aligned interests, of course - begin.