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EXPLOSIVE: Lehman - Where Are The Cops?

nospam@example.com (Karl Denninger) — Thu, 11 Mar 2010 20:40:00 -0500

Sarbanes-Oxley was supposed to prevent crap like this:

From the paper:

Lehman employed off-balance sheet devices, known within Lehman as “Repo 105” and “Repo 108” transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days, and to create a materially misleading picture of the firm’s financial condition in late 2007 and 2008.2847

Oh yeah, that's legal? It's not supposed to be!

Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet.2850 Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transaction – i.e., although Lehman had in effect borrowed tens of billions of dollars in these transactions, Lehman did not disclose the known obligation to repay the debt.2851 Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios.

Isn't that special?

It gets better, as you might expect.

The Examiner concludes that colorable claims of breach of fiduciary duty exist against Richard Fuld, Chris O’Meara, Erin Callan, and Ian Lowitt, and that a colorable claim of professional malpractice exists against ~~Arthur Anderson~~ Ernst & Young.2915 (strikethrough mine, not in the original)

It is stated that Government Regulators (FRBNY and The SEC) had "no knowledge" of these practices. Perhaps true. But this calls into question why we're hearing of this just now, and whether other firms have or are at present doing the same sort of thing.

There also appears to be a colorable claim that Lehman Management was fully-aware of what was going on:

Although interview statements given to the Examiner were inconsistent at times, no reasonable dispute exists that each of Lehman’s Chief Financial Officers from late 2007 to September 2008 possessed some knowledge of and/or involvement with multiple aspects of Lehman’s Repo 105 program, including the existence of firm-wide Repo 105 limits, the volume of Repo 105 activity Lehman engaged in at quarter‐end, and Lehman’s efforts to manage its balance sheet using Repo 105 transactions.

Well that's special.

But we're just getting warmed up.

Remember, The Feral Reserve is supposed to by the "uber-regulator" and the "safety and soundness" manager for the financial system.

They did a great job, right? Well...

For example, when

the Examiner questioned Lehman executives and other witnesses about Lehman’s financial health and reporting, a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.

True? Let's see what the Examiner had to say:

Although various Government agencies had information that raised serious questions about Lehman’s reported liquidity and about the sufficiency of its capital and liquidity to withstand stress scenarios, the agencies generally limited their activities to collecting data and monitoring.

Oh. They looked but didn't act. I see.

Indeed, they looked pretty closely....

After March 2008 when the SEC and FRBNY began onsite daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more rigorous stress‐testing scenarios to test Lehman’s ability to withstand a run or potential run on the bank.5753 The FRBNY developed two new stress scenarios: “Bear Stearns” and “Bear Stearns Light.”5754 Lehman failed both tests.5755 The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed.5756 However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed.5757 It does not appear that any agency required any action of Lehman in response to the results of the stress testing.

So let's see what we got here. They ran two sets of stress tests and the firm failed both. Not satisfied with the results they then designed a third set, which the firm also failed (we can reasonably presume the third had less stringent requirements than the other two!)

Instead of applying any of these three, FRBNY, which was run by one MR. TIMOTHY GEITHNER, NOW OUR TREASURY SECRETARY WHO REPORTED TO ONE BEN BERNANKE, instead took Lehman's word that all was ok and did nothing.

Nor did it end there.

The SEC inspection revealed significant problems at Lehman. The SEC found that Lehman’s Price Valuation Group was understaffed; and it found that Lehman’s asset pricing function was overly “process driven.”5761 But the SEC did not release its findings or formally present them to Lehman prior to Lehman’s demise.

So The SEC knew, and they too did nothing.

It's worse. While Geithner is implicated as being "concerned" about Lehman in the paper, the most-troubling part the narrative is here:

The challenge for the Government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in “collateral damage” by demonstrating weakness and exposing “air” in the marks.5823

Air?

Uh, that's an apparent admission that FRBNY and Tim Geithner specifically knew that the marks that these banks were taking on their assets was materially and intentionally false.

Where have we seen this of late? Oh yeah - in all those banks that have failed of late, with 25-40% discounts to their claimed balance sheet values when the marks are actually reduced to losses to the deposit fund by the FDIC!

So let's see here. We now have:

Geithner, and presumably everyone under him, knew the marks on these assets were fictions months before Lehman failed, yet they intentionally concealed this fact from the market and took no action (nor did the SEC) to disclose this intentional misdirection.
The misdirection and false claims in this regard are almost certainly continuing today, as evidenced by the FDIC seizures literally on an every-week basis.

How about Bernanke? While he maintains (as did Geithner) that primary responsibility lay with the SEC, he also said:

Our concern was about the financial system, and we knew the implications for the greater financial system would be catastrophic, and it was.”

What does all this say about the stability of things now?

Yeah, I know, everyone's "too big to fail."

But what if the truth is that they're "too big to bail", for instance, if one of the "big four" was to get in trouble today due to a recognition in the marketplace that not only is this what blew up Bear Stearns and Lehman Brothers, but that the same chicanery with "asset values" is continuing even today, and as such one cannot be reasonably certain that liquidity provided today will be repaid tomorrow?

Why is it that if the implications would be catastrophic (and they were), both the SEC and FRBNY knew that Lehman had insufficient liquidity long before the collapse (and they did) neither the SEC, The Federal Reserve or FRBNY did a damn thing to blow the whistle on this crap and put a stop to it?

This report sets out a damning case against the pseudo-government and government actors, who it is alleged were well-aware of critical weaknesses in Lehman's risk controls and liquidity months before it collapsed, yet none of them did a damn thing about it until days before the bankruptcy filing.

Why should any of the clown-car riders who clearly knew that this situation existed for literal months before it blew up, yet did nothing, still retain their jobs and, in Geithner's case, obtain a promotion? These people are unqualified for supervisory positions involving anything more complicated than handing out towels in the men's room.

The key question facing the nation this evening is not, however, the past. It is the future. We have over 100 literal instances in which banks have been seized by the FDIC since Lehman blew up in which their balance sheet "asset values" have been shown by the FDIC's own DIF loss projections to be abject fictions, yet none of these institutions have been flagged to investors or the public, no indictments or civil complaints have been brought by the SEC or Department of Justice, and they have remained operating for months with these bogus values exhibited for bank examiners and regulators to see.

IF - and I stress IF - these fictions are also present in our large banking institutions, and there is NO REASON TO BELIEVE THEY ARE NOT, it is simply a matter of time before one or more of them detonates in a similar if not identical fashion. Since these firms are all much larger than Lehman and neither the FDIC or Treasury has a spare $500 billion laying around for the potential payout to depositors that might be necessary in such an instance, we cannot reasonably assume that the risk of financial Armageddon has in fact passed until we know for a fact that all fictional balance sheets are excised and all off-sheet exposures accounted for.

Ponzi City Government: Chicago

nospam@example.com (Karl Denninger) — Thu, 11 Mar 2010 13:42:00 -0500

Ok Daley, nice bleat:

Mayor Daley warned today that the day of reckoning has arrived for a financial crisis that’s choking local taxpayers: underfunded city pensions.

Daley said the 32-member pension commission he created more than two years ago will soon recommend solutions to the crisis that won’t be pretty or politically popular.

What's the primary problem? Try right here:

He cracked the door open to raising the retirement age from the current minimum of 50. He said he would consider raising employee contributions and implementing a two-tiered pension system that shifts newly-hired employees to the 401k plans favored by private industry.

Can I have my Social Security - full benefits - along with Medicare at 50? That's only three years form now. Sounds pretty good.

Why not?

Because the Federal Government would go broke in about a year if we tried this nationally.

So who thought it was a good idea to do this with City (and State) employees?

Where the hell were you, Mr. Daley, back in the 1990s when I ran a business in your putrid, corruption-infested town?

I'll tell you where he was: he had the public sector unions under his desk taking turns giving him fellatio in return for endorsements and votes, that's where.

Now, having basically bankrupted the City, he, like a number of other mayors and governors is bleating about how horrible the situation is - a situation he was responsible for creating!

Oh, and instead of facing this years ago his "response" to the early warnings was to sell off the parking meter revenues via a "forward" (in effect) and then blow the money, thereby destroying that which was in fact a decent city asset.

This sort of stupidity is nothing new and now there's no ability to avoid a truly nasty set of consequences.

Of course deposing the Daley monarchy is a bit of a problem when you have a plurality of people who suckle on the teat.

When the teat runs out of milk Daley might want to consider how the fine citizens that would otherwise guarantee his re-election might choose to refill the udder they're used to being able to suckle from.

New Fed Z1: Market Move Is NOT Sustainable

nospam@example.com (Karl Denninger) — Thu, 11 Mar 2010 12:54:00 -0500

Sorry guys and dolls.

The new Fed Z1 is out, and it makes clear exactly what's going on when it comes to the broader economy.

This isn't a market timing call, but it is an inevitable recognition of reality call - and it will come.

Note that the Federal (and to a lesser extent the State) governments have replaced credit expansion in the broader economy but it is not working anyway, as total outstanding credit continues to shrink. That is, the Q3 contraction "on balance" was not a statistical one-quarter fluke.

As of the 4th Quarter of 2009 there is no evidence of recovery in the broader economy's credit growth; to the contrary, it continues to shrink despite the government's attempts to halt it.

Here's some more detailed color on this:

Find the rising economic activity, as measured by the debt load in the system. Hmmm... let's see, a little bit in State, down everywhere else, except..... The Federal Government!

The Federal Government went from $5.122 trillion to $7.805 trillion in 24 months. That's $2.68 trillion dollars in 24 months, or almost exactly ten percent of GDP in net Federal borrow-and-spend to prop up consumption and output.

How long can this continue?

The economy operates on credit folks. Every category of net final private demand and economic activity is contracting. ALL OF THEM. The Federal Government is engaged in a furious game of "blow up the doll" while one of its fingers is cut off and the air leaks out faster than they put it in! This is shown by the top graph, which reveals that even with the Federal Government's machinations total economic activity as measured by credit outstanding continues to decrease.

Folks, there's no recovery. Not through Q4 2009 anyway. The Fed Z1 does not lie and the destruction in the financial space continues at breakneck speed, despite the idiots who think that buying stock in these companies is a good idea.

Best-a-luck folks if you're listening to ToutTV - there's a "use by" date on this nonsense, and if you find yourself on the wrong end of it you will not like the consequences.

Is That Fear I Sense? (CDS Regulation)

nospam@example.com (Karl Denninger) — Thu, 11 Mar 2010 11:38:00 -0500

Amusing how Bloomberg comes out pumping the CDS monster:

March 11 (Bloomberg) -- European politicians and regulators could initiate a continent-wide ban on speculative trading of sovereign credit-default swaps tomorrow. Making it stick without the Americans won’t work.

Oh there you're simply wrong, my friends. The assertion is made:

“You need to get the U.S. on board, otherwise the effect will be minimal because trading will simply move elsewhere,” said Jan Hagen, head of the financial services group at the European School of Management and Technology in Berlin. “A ban would allow European politicians to tell voters at least they’re doing something.”

On the contrary.

EU nations can pass laws and regulations that make the collection of bets placed in this fashion unenforceable. That is, you're free to write all the swaps you want over in London, but you can't force anyone in the EU to pay when the bet goes against them.

This, incidentally, is exactly what the Dutch did when Tulip Mania blew up. They declared all the contracts that had been written against Tulip Bulbs (which were an awful lot like a CDS!) to be unenforceable gambling contracts and thus void.

POOF!

Such a law, if passed EU-wide would make the European Union a haven for corporations and even banks. No longer could you be attacked within the EU - and frankly, who gives a tinker's damn what London or Wall Street thinks if they can't reach into your firm if and when their contracts go bad!

Oh, and if you think the Europeans don't have a real solid reason to do this either individually as nations or collectively, you're wrong. Italian cities, for example, appear to have been scammed with swap contracts written in English rather than their native language by a bunch of High Street shysters. They're now bleeding from all orifices on these "deals" and looking for a clean way to stop it.

This is the way to do it and it's entirely within their rights as sovereign nations to do so, just as it is ours.

Should the EU do so America would be forced to go along, lest it be effectively depopulated in terms of large financial and industrial concerns. Same with Britain.

So go ahead and put forward this sort of BS "firebreak" kind of argument, Bloomberg. It's abject nonsense.

The creation of a "safe haven" where fraudulent swaps are no longer enforceable would be of tremendous benefit to the western world.

If London and Wall Street have managed to bribe their respective governments to a degree that makes banning fraudulent conduct impossible, then we will simply have to look to the Europeans to take the proper - and long overdue - step forward in fixing this problem, and suffer the consequences in the loss of both jobs and companies that come from the "big banks" obfuscation and BS.

Oh Mr. President and Congress (El-Erian)

nospam@example.com (Karl Denninger) — Thu, 11 Mar 2010 09:03:00 -0500

Well now this is a rather interesting editorial:

Today, we should all be paying attention to a new theme: the simultaneous and significant deterioration in the public finances of many advanced economies. At present this is being viewed primarily - and excessively - through the narrow prism of Greece. Down the road, it will be recognised for what it is: a significant regime shift in advanced economies with consequential and long-lasting effects. To stay ahead of the process, we should keep the following six points in mind.

El-Erian goes on to list six points that make most people's eyes glaze over. Indeed, the entire editorial is one of those things that reminds one of Alan Greenspan and his famous "how to write 3,000 words and yet never find two people who agree on what you said."

The final three paragraphs are worth reading though:

This leads to the sixth and final point. We should expect (rather than be surprised by) damaging recognition lags in both the public and private sectors. Playbooks are not readily available when it comes to new systemic themes. This leads many to revert to backward-looking analytical models, the thrust of which is essentially to assume away the relevance of the new systemic phenomena.

You mean things like taking in 30% of what the government spends via taxes, then dismissing this as "oh we'll just issue some more T-bills"?

There is a further complication. Timely recognition is necessary but not sufficient. It must be followed by the correct response. Here, history suggests that it is not easy for companies and governments to overcome the tyranny of backward-looking internal commitments.

Uh, did you parse that one folks?

".....tyranny of backward-looking internal commitments"

That's code for "entitlements that were promised to people but cannot possibly be provided, no matter how long people howl - or how loudly."

Where does all this leave us? Our sense is that the importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood. Yet, with time, it will prove to be highly consequential. The sooner this is recognised (sp), the greater the probability of being able to stay ahead of the disruptions rather than be hurt by them.

Forget it. One need only look to Greece, where telling people they have to actually go to work and produce something in order to earn a public-sector salary produces riots.

If you think we're "more advanced" in our thinking here in the United States you're simply insane.

Times like this require a man in the left seat with a big fat church-bell sized set of balls, and the willingness to be unpopular enough to be a one-term wonder. This is inherently in conflict with the narcissist personality required to run for President in the first place.

Nobody who wants the job and is electable to the office is fit for it at a time like this. I'd do it if drafted, but I'd never put up with the crap required to get there, nor am I electable - because I refuse to lie in the fashion required to obtain the office. Stumping for votes while pointing out that promising to pay $100 trillion in Social Security and Medicare that we don't have and can't acquire, that if we try to print our way out of debt that "obligation" will go from $100 trillion to $250 trillion (which still can't be paid), and that the sort of measures required to bring the economy and government back into balance - at both a state and federal level - will result in massive shifts in the economy's balance and, in the short-term, lead to even more pain, are not popular. To the contrary - not one person receiving those handouts would vote for me, and since they're nearly half the population there's not a snowball's chance in Hades that I could carry the day at the polls.

So what's required is a paradox. You need a man or woman who will run for the office saying all the "right things" while lying through their teeth. Someone who will shed that veneer the instant the election is over, then take the left seat and be a five-alarm bastard once in office, placing a big sign on the door "$ = NO!"

Someone who will take a look at The Constitution and if they can't find whatever it is being proposed in the four corners of the text, it's gone. That is, Social Security and Medicare - gone. Provide some sort of subsidy to the states with whatever we've actually got in the so-called "Trust Fund" (that is, distribute to them the "special Treasuries" in the so-called "box") and immediately end FICA. The States are then free to run the programs as they see fit. This will instantly force accountability and a transition to a privately-owned pair of accounts, or perhaps one account that provides both functions, since people move and won't accept anything else.

Someone who will align tax revenue with GDP permanently and radically. This means The Fair Tax, and if Congress won't enact it, then The President does it by executive order - by abolishing the IRS' funding and authority! Issue an executive order barring the DOJ and other Federal Law Enforcement from enforcing anything in The Internal Revenue Code, and suddenly Congress will become far more reasonable since in order to acquire funds they will have to do the right thing. Radical? Yes. Bye-bye 16th Amendment and "K Street."

Now go find the rest. Departments of Education and Agriculture, as just two examples: Gone. All State Mandates from The Federal Government: Gone.

If you can't find it in The Constitution it goes back to The States and is regulated within their borders. The ability of the people to freely migrate from one state to another enforces fiscal responsibility - if you behave like a jackass, such as California has done, you will be rapidly de-populated and without a tax base, your policies fail. End of discussion. No more Federal Welfare of any sort. If The States want to provide it and can fund it, goody for them. More likely what happens is that The States suddenly find that they can provide lots of workfare doing things that need done, provided they outlaw public employee unions first to disarm those thugs.

On monetary policy it's simple: The Fed either honors its actual written mandate or they're gone too. No more BS, no more opacity. Everything they do is public and published on The Internet. Send up a bill mandating that any gaming of economic statistics or monetary policy is a federal offense garnering you 20-to-life in the can and demand that it pass or you'll veto every bill that comes to your desk until it does.

On Credit Default Swaps and other instruments: All trade on a public exchange. All exchanges in the US are public, non-profit organizations. The Federal Government will run one and The States are welcome to set them up too - but only as public non-profits. National Best Bid and Offer (NBBO) is guaranteed by law with felony criminal penalties for anyone gaming it - like offering "Flash Orders." Any federally-chartered institution that fails to adhere to One Dollar of Capital is instantaneously closed - without exception. All firms trading on a public exchange or doing business in The United States across state borders (and therefore under proper federal regulation) is required to produce full, complete and truthful financial statements, without exception. This means the use of off-balance sheet anything is absolutely prohibited under pain of immediate delisting and felony fraud prosecution.

We adopt a national policy that tariffs are set to provide wage parity. This will produce howling from the WTO. Tough. No longer will we permit wage arbitrage as a reason to offshore jobs. This is not only Constitutional, it is the premise upon which this nation was founded in terms of how the Federal Government is supposed to acquire its funds! Combined with The Fair Tax, which will make the United States a corporate tax haven (zero corporate and personal income tax rate) this will result in an instantaneous flood of manufacturing and high-tech jobs back into the United States - all GDP boosters. The United States GDP would double within a decade.

Refuse to sign any budget that does not run a primary surplus, except in times of declared war. If Congress or The Administration wants to play International Cop it either funds the entire thing on-budget and pays for it or declares war and has the ability to do so via deficit spending.

Adopt Freedom's Vision for monetary policy. No more debt-backed currency. If The Fed doesn't like being relegated to a clearing house for payments that's too damn bad. Tell the CFTC you'd like them to list a "boiled rope" futures contract just to underline the point.

Radical? Yes.

The only solution long-term? Yes.

Will it happen? Not unless our present Administration grows a set of balls, which it does not at present possess, or someone is willing to both lie themselves into office and then do it anyway.

As a consequence what El-Erian is talking about will happen - an "unexpected" recognition of the reality that what is being done today both is unsustainable and won't work, but we will do nothing appropriate about any of it until we find ourselves well-off the cliff and furiously pedaling in the air like Wile-E-Coyote - and at that point it will be to late to avoid the ugly consequences.

What's Our Credit Limit Again?

nospam@example.com (Karl Denninger) — Wed, 10 Mar 2010 14:18:00 -0500

50% of the federal budget right now goes to entitlements.

This last month we posted a record $220.9 billion budget deficit. We took in $107 billion but spent $328 billion.

Isn't that special. We only funded 32% of expenditures?

Remember - entitlements were half of that $328 billion.

So let's see if we can do the math here.

Entitlements were about $164 billion last month in spending. The rest was, of course, the rest.

But we only took in $107 billion.

So even if we eliminated all entitlement spending we still did not have enough money to cover the rest.

Yeah.

If you want to know why the market is floating higher it's for the same reason you feel all giddy and special when you strike out on the town with your shiny plastic. You have magic cards!

It doesn't matter if you have a job, it doesn't matter if you have any money in the bank, so long as you have magic cards.

For how long does the United States continue to have magic cards?

Remember, from my ticker the other day, the federal government is directly spending 9% more of GDP today than it was just two years ago.

The market and economy are absolutely dependent on the Federal Government continuing to do so. Should the government not be able (or willing) to continue to do so, S&P 666 or DOW 6,489 will look like a bull market.

Now add to this that the continued spending in this fashion inevitably will cause interest rates to rise. It simply must, whether that interest rate increase comes from actual Treasuries, or whether it comes from dollar devaluation and thus causes oil - and by extension virtually every other price in the market - to rise at a meteoric rate.

Oh, and if they choose the second (inflation)? Then, as I discussed earlier, that entitlement spending, which is set to go parabolic anyway as the boomer retire, will have an afterburner attached to its backside due to the fact that all of these programs are indexed to "inflation", with Medicare in particular being indexed at several multiples of inflation.

But for today, folks, it's "Rally On Garth" - even though all of the above is not conjecture, it's mathematical fact and inevitably must come to pass.

Bank Of America To Stop Charging 31,200% Interest

nospam@example.com (Karl Denninger) — Wed, 10 Mar 2010 09:57:00 -0500

No, that's not a misprint.

Let's say you went to Starbucks and bought a $5 Latte. You swiped your debit card and didn't have the $5 in your account.

Bank of America would charge you a roughly $30 overdraft fee, amounting to 600% of your purchase for a loan of that $5 for as little as one day. That's bad enough.

Let's assume you paid that overdraft fee (and the $5) in one week. There are 52 weeks in a year and the bad news is that when computing the annual percentage rate you must divide the interest charged by the percentage of a year you held the money to get the APR. Thus, 31,200% interest on an "annualized" basis, assuming you pay it in one week (it's 218,400% if you pay it off the next morning!)

The bank will soon stop doing this, and in fact is mandated to do so without getting permission first for each transaction, as of June 1st.

The question that should be asked is why we should have to wait until June 19th for new accounts, or August 1st for existing accounts, never mind why this sort of outrageous behavior has been permitted in the first place.

Guido on the corner typically will charge you something obscene like 500% interest over the course of a year.

The banksters put Guido to shame.

How much do the banksters make off this? Some $1.77 billion annually, at last count. None of which, I might add, will be refunded to their customers.

The banking industry has claimed that changes like this will "restrict credit" to lower-income customers, who allegedly "need" that credit.

I will simply observe that nobody "needs" a 31,200% interest rate loan except the bank that has been given license to rob the public blind - literally.

If you were wondering who the Congress and Fed work for, it clearly is not you.

The open question, and one that I cannot seem to find a reasonable answer to, is why we, the people, continue to allow both a Congress and Federal Reserve to sit in control of our government and financial system when they permit and endorse actions that constitute financial rape of such an egregious nature that absolutely everyone can understand it.

GreeceFire Out? I Don't Think So...

nospam@example.com (Karl Denninger) — Wed, 10 Mar 2010 08:20:00 -0500

The idiocy coming from the EU reeks of desperation:

“For Greece, the problem is completely over,” said Prodi, who was also Italian prime minister, in an interview in Shanghai today. “I don’t see any other case now in Europe. I don’t think there is any reason to think the euro system will collapse or will suffer greatly because of Greece.”

Continuing...

Prodi, 70, who headed the European Commission from 1999 to 2004, will teach at the China Europe International Business School in Shanghai. He said budget deficits are “a general problem for almost all the wealthy countries.”

No, really? You mean having the government be responsible for half of GDP is a problem, when everything that they actually obtain has to come, in the end, by taxing the citizens inside their borders?

The euro has weakened 5.8 percent against the dollar this year as concern Greece will struggle to finance its deficit eroded confidence in the European currency.

“Europe is more than happy,” said Prodi. “For the benefit of the European economy, the decrease of the value has been absolutely positive.”

Bah.

As in the United States, European nations more-or-less index their entitlement programs to inflation. And like the United States, they hold most of the costs of these programs off their balance sheet, where that indexing is not visible (directly) to markets, never mind that those are promises for tomorrow, not today.

It is here that the theories of all those so-called "economists" who claim that we "benefit" through currency devaluation by "inflating the debt away" have their thesis run head-on into a brick wall.

In the United States, for example, our "forward liability" for those entitlement programs is somewhere between $60-100 trillion, depending on who you ask. The on-balance sheet public float of the debt is about $8 trillion.

So let's assume we try to double that over the remainder of the decade (as the economists believe we both must and will) the only way to make that able to be carried is to devalue the currency through money-printing - "monetization", if you will.

But doing so, because of the indexing in these entitlement programs, causes their forward costs to explode.

Let's take an example and run the "forwards" on it. We will assume that the "current" cost of a set of entitlement programs is $5 trillion, but it is to be delivered in 30 years. If the forward implied inflation rate is 2%, as Bernanke claims is the "goal" (1-2% annually) then the 30-year forward implied cost of this program can be easily calculated since it is simply the compound growth rate over that time. In this case, that program has a "forward" (or "as delivered in 30 years") cost of $9.06 trillion.

But now let's assume we decide to "inflate away" the debt as "suggested" by the IMF (and on which point, I might add, Bernanke was grilled in his last testimony before Congress) by raising the inflation target to 5%. That's not all that bad, right? It's only three more percent!

Well, except for one small problem - that inflation rate drives the delivered cost of this entitlement from $9.06 trillion to $21.6 trillion, well more than a doubling, and what's worse is that this additional cost totally destroys any "savings" in debt payment ability that would otherwise be generated by attempting to inflate away the "on balance sheet" debt amount.

In the case of the United States, of course, the forward cost is already $100 trillion. Attempting to "inflate away" our $8 trillion (today) of public float, or the $17 trillion that the CBO says we'll have by 2020, would cause that $100 trillion to explode upward. Indeed, simply trying to get "a bit of relief" with a 5% inflation policy would more than double it, and an actual attempt to inflate it off over the course of ten years (which would require approximately a 7% inflation rate) would cause that $100 trillion forward liability to balloon to more than $300 trillion.

With that it should be obvious that any attempt to play "inflate it away" will simply never work. It will and must cause the immediate detonation of all forward-promised social entitlement programs, and when you have placed half or more of the population at the time in a position of effective dependence on those programs attempting such a foolhardy path of action is guaranteed to lead to the total destitution of half or more of the populace.

Since it is an essential certainty that a population so-impoverished will inexorably rise in violent revolution there is a clear argument that can be made that any such suggestion or policy, whether made publicly or "in the dark of the House Cloak Room", is in fact a violation of US Code, Title 18 Chapter 115 Sec2385, which provides in part:

Whoever knowingly or willfully advocates, abets, advises, or teaches the duty, necessity, desirability, or propriety of overthrowing or destroying the government of the United States or the government of any State, Territory, District or Possession thereof, or the government of any political subdivision therein, by force or violence, or by the assassination of any officer of any such government; or

Whoever, with intent to cause the overthrow or destruction of any such government, prints, publishes, edits, issues, circulates, sells, distributes, or publicly displays any written or printed matter advocating, advising, or teaching the duty, necessity, desirability, or propriety of overthrowing or destroying any government in the United States by force or violence, or attempts to do so; or

Whoever organizes or helps or attempts to organize any society, group, or assembly of persons who teach, advocate, or encourage the overthrow or destruction of any such government by force or violence; or becomes or is a member of, or affiliates with, any such society, group, or assembly of persons, knowing the purposes thereof—

Shall be fined under this title or imprisoned not more than twenty years, or both, and shall be ineligible for employment by the United States or any department or agency thereof, for the five years next following his conviction.

As such anyone advocating this course of action must be held to account under the existing laws of The United States which make the advocacy of such acts punishable by 20 years in the hoosegow.

(Never mind that it won't work!)

A Random Look at RMBS And The Economy

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

From The Forum:

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.

IF You Are Going To "Demonstrate"....

nospam@example.com (Karl Denninger) — Tue, 09 Mar 2010 19:56:00 -0500

Then aim your "demonstrating" at the people who are bankrupting your state - and you personally.

I speak specifically of people such as those that The Daily Illini pointed out - all employees for the University of Illinois.

Let's see what we have here....

The head of the football team - the coach - makes $1 million. For coaching a college football team.

The "intercollegiate (sports) director makes $600,000.

The President of the University is just $50 large shy of a half-million.

A large number of Deans and Professors make $250,000 - or more.

Indeed, I have to get eight pages into this list before I drop below $200,000.

Oh, we also have two Lieutenants in the Police Department that make $192,545 - each - per year. Handing out tickets to scooter riders without helmets and issuing University Parking Citations (probably more than $200,000 worth of those) I'm sure.

Now maybe you can justify how it is that these fine bastions of American Government Employment earn these bloated salaries.

I will point out some demographics to readers for Champaign-Urbana, Illinois, where the University happens to be.

The median home price is $159,900, which the top fifteen pages of these employees can afford to pay cash for with one year's salary.

The median income for a family is $52,628, while per-capita income according to the BEA is $31,354. Fewer than FIFTEEN PERCENT of the persons on the University Payroll make equal to or less than the median per-capita income for the city.

Oh, and let's not discuss retirement benefits. Legacy pensions anyone? How about medical care once one retires. And speaking of which, what's the retirement age?

There has been much written about overblown pensions, double and even triple-dipping and similar games. But this table, nicely sortable by salary, makes quite clear exactly who the system employs and how much they pay - and that the pay is, shall we say, ridiculous compared to the average private-sector prevailing wage.

This much should be clear: If you're curious about why you're being bankrupted with parabolic tuition and fee increases along with demands to take on outrageous amounts of debt to get a so-called "college education", you might discern from the above that the only "educating" you're getting in the UofI system is how to hold still while you're bent over the table and violated.

What you, Dear Student, who is being given the whaaaaambulance treatment by the Administration (the folks making those six-figure salaries that are all radical multiples of the average living wage in your town) do about that "education" is, of course, up to you.

The CISCO Hype Machine

nospam@example.com (Karl Denninger) — Tue, 09 Mar 2010 11:33:00 -0500

This is simply unbelievable.

Cisco CRS-3, powered by Cisco QuantumFlow Array - a chipset architecture engineered in multiple dimensions of scale, services, and savings.

That's the announcement. It was the cause of all the hype. A "new dimension" that works within their existing CRS framework.

Basically, a faster version of the CRS-1.

CISCO claimed in his hype that:

The San Jose, Calif.-based Cisco had sent out invitations to analysts and the media for a "significant announcement" that it says "will forever change the Internet and its impact on consumers, businesses and governments."

Oh Jesus.

You'd think there was some new technology. Something that nobody had seen before. Something revolutionary.

You would be dead wrong.

Now don't get me wrong - more speed is good, of course. More capacity is good. More density - an increasing problem for various network folks, is never a bad thing, although there's no such thing as a free lunch - more capacity in a smaller space comes with higher power requirements and heat loading, which in turn invalidates assumptions made by carriers, ISPs and others on the adequacy of power and cooling systems in their machine rooms - sometimes with extremely expensive consequences.

But "forever change the Internet and its impact on consumers, businesses and governments"?

HORSECRAP!

This reminds me of the hype when the CISCO 7xxx carrier series routes were introduced in the 1990s. These were "going to change the Internet forever" too.

But that was a forced upgrade CISCO was able to capitalize on due to their near-monopoly position in the core routing space at the time.

What was only known to people who understood the Internet at the time (myself included) was that the reason that device garnered instant acceptance and huge order flow was that the Internet's routing table was exceeding the storage capacity of the CISCO AGS+ which was, at that point, mostly at the core of the network. Carrier routers were literally crashing as a consequence of running out of memory, and the architecture of the AGS+, which was roughly-based on the VME backplane architecture and the Motorola 68xxx processor line, did not allow for expansion of the address space.

In other words CISCO had painted itself into a corner and its response was to come out with a new, improved architecture that didn't have those limits - and the Internet's address space expansion effectively forced every ISP in the United States to buy their 7xxx series gear almost immediately.

But this is a different matter entirely. There is no "forced corner" that CISCO can exploit here, there is no monopoly position in the marketplace as there was with the AGS+ 20ish years ago and while this is obviously a step forward in performance-per-unit-of-density the firm's claims are, in my opinion, dramatically overblown.

I used to have respect for John Chambers. Not any more.

That John Chambers sees it necessary to resort to this sort of over-the-top hyperbole unfortunately causes me to have flashbacks of 1999 - when every "technology company" had their stock pumped day after day by releasing utterly overblown and outrageously hyped press releases, while the actual market impact of what made it to market was more akin to a mosquito biting an elephant's ass.

Let's hope what follows for those who buy into this bilge isn't March of 2000.

Disclosure: No position.

PS: Would you mind disclosing the particulars and performance of the off-balance-sheet financing you're carrying back for people - and the terms on that financing? (p63.) I'm just curious if there's been some, uh, "deterioration" in the credit quality in that nice black box. Thanks in advance for what I expect will be a non-answer.

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.

ADMISSION By FDIC: Massive Balance Sheet FRAUD

nospam@example.com (Karl Denninger) — Mon, 08 Mar 2010 13:02:00 -0500

Remember this Ticker from a few days ago?

I am constantly amused by those people who claim there is some vast "conspiracy" in this country when it comes to banks, balance sheets, and fraudulent lending and accounting.

There is no conspiracy.

It is, in fact, "in your face" fraud.

Well, one of the people on the forum emailed The FDIC to ask about what I had alleged. This was their response:

That’s the value the bank had them on their books on their year-end financials, but the true value is much less. It is similar to someone in Las Vegas saying that their house is worth $300,000 because that’s what they paid for it three years ago, but the reality is, if they had to sell it in today’s market, they’d only get $250,000 for it. The FDIC has to sell assets in today’s market.

--db

Or tomorrow's market.

The simple fact of the matter is that there it is, right in front of you.

A raw admission that the banks are carrying these loans at dramatically above their actual value.

Yes, this means that essentially all balance sheets must now be considered fraudulent, and thus the valuations assigned by the market to them are also fraudulent.

Extending this to the stock market as a whole you now have a market that is intentionally overvalued as a direct and proximate consequence of fraud, permitted and endorsed by the government, of somewhere between 25-40%.

Now you know why the market rallied off the SPX 666 lows to where it is now. 1139 (where we are now) * .60 (a 40% haircut) = 683.40, or awfully close to that 666 bottom.

Of course this "valuation" expressed in the market can only be maintained for as long as the fraud is. If the ability to maintain that fraud is lost for any reason then values will instantly collapse back to reflect reality.

Still sleeping well with your investments?

Janet Is On It Again (Sovereign CDS)

nospam@example.com (Karl Denninger) — Mon, 08 Mar 2010 10:43:00 -0500

From Huffington Post:

Congress should act immediately to abolish credit default swaps on the United States, because these derivatives will foment distortions in global currencies and gold. Failure to act now will only mean the U.S. will be forced to act after these "financial weapons of mass destruction" levy heavy casualties. These obligations now settle in euros, but the end game is to settle them in gold. This is so ripe for speculative manipulation that you might as well cover the U.S. map with a bull's-eye.

She then continues with information I was unaware of:

U.S. credit default swaps currently trade in euros. After all, if the U.S. defaults, who will want payment in devalued U.S. dollars? The euro recently weakened relative to the dollar, and market participants are calling for contracts that require payment in gold. If they get their way, speculators on the winning side of a price move will demand collateral paid in gold.

WHAT?!

OK, that's enough.

Congress must ban all credit derivatives that are not:

Sold over an insured interest, that is, if you don't own the bond you can't buy the "insurance" AND
Are not sold by an entity with proved, marked to market night ability to cover each and every contract sold.

That is, these things must be treated as insurance and regulated as insurance.

What we have now are literal hundreds of trillions of dollars of fraudulent paper contracts to pay a sum that the writer does not have, written for speculative (or worse, regulatory avoidance) rather than hedging purposes. These contracts are destabilizing, they are impossible to perform on without government backstop (as we saw with AIG) they are being sold at dramatically less than their true economic value (otherwise we wouldn't have had to bail out AIG) and they're being sold and used for either speculative purpose or worse, as a means of fraudulently avoiding regulatory constraints.

Congress must act to stop this crap now.

More Balance Sheet Fraud: Its INTERNATIONAL!

nospam@example.com (Karl Denninger) — Mon, 08 Mar 2010 08:32:54 -0500

Greece, Spain, Portugal, Dubai, China, The US: They're all doing it. Barney Frank gets caught endorsing the scam in 2009, then bleating in 2010. The Euro Zone and China both are in this scam up to their necks. Of course so are we with Social Security and Medicare. Why the economy cannot - and will not - truly recover until this is addressed.

Barney Frank: The Liar Is (Again) In The House

nospam@example.com (Karl Denninger) — Mon, 08 Mar 2010 08:07:00 -0500

Will this man ever take responsibility for what he does?

Many second liens have little value because of the plunge in home prices, Rep. Frank wrote, adding: "Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans."

How did that happen Mr. Frank?

Oh yeah, I remember! Your committee pressured FASB to drop "mark to market" accounting requirements last year!

That is, YOU were personally responsible for this crap.

Remember the subcommittee hearing chaired by your fool-in-chief Mr. Kanjorski? I remember that circus show of horrors well. In case you've forgotten, let me help jog your memory:

Washington, DC – Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, today announced that the Subcommittee will hold a hearing to examine the mark-to-market accounting rules that many contend have exacerbated the current troubles in the financial industry and in the broader economy. The standard requires companies to value assets they hold at current market values. For assets that are frozen and have a diminished current market value but may recover value in the future, the standard has proven problematic. Companies are then forced to write-down billions in assets, which can lead to further write-downs elsewhere.

Like second mortgages, for instance?

Yeah.

This hearing was what prompted those banks to mark those loans to fantasy values, a practice they are still continuing to this day, even though if the first is underwater and goes into foreclosure the second is in fact worth zero.

Therefore, a first that is both underwater and is late by 60 days or more is almost certain to either short sale or foreclose ultimately, and under mark to market rules the second would have to be written off.

But your committee, which sits over the subcommittee on Capital Markets, effectively bludgeoned FASB into legalizing the accounting fictions that you now complain about.

Indeed, the testimony of FASB was that:

The fact that fair value measures have been difficult to determine for some illiquid instruments is not a cause of current problems, but rather a symptom of the many problems that have contributed to the global crisis, including lax and fraudulent lending, excess leverage, the creation of complex and risky investments through securitization and derivatives, the global distribution of such investments across rapidly growing unregulated and opaque markets that lack a proper infrastructure for clearing mechanisms and price discovery, faulty ratings, and the absence of appropriate risk management and valuation processes at many financial institutions.

None of which, I might add, your Committee has bothered to address.

Having done nothing but bleat and ram down the throat of FASB changes in accounting standards that have legalized outright balance sheet fraud, you now have the temerity to complain about the results, when I and many others said at the time this would be precisely what would happen.

The solution to the problem is, of course, to reverse the outcome of that idiotic hearing and restore mark-to-market accounting forthwith for all bank assets.

Go look in the mirror Mr. Frank - you made this mess yourself, and while you're at it drag that clown-car occupant Kanjorski with you.

Oh, The Off-Balance Sheet Lies Are International?

nospam@example.com (Karl Denninger) — Sun, 07 Mar 2010 16:26:00 -0500

Naw, they'd NEVER do that, would they?

International finance-industry estimates have Dubai's sovereign debt load, thanks to the off-balance-sheet debt, exploding to nearly four times its originally reported $80 billion, as other government-backed projects have gone bad after Dubai World's default in late November.

....

This is how the Greek debt has grown 12 times over the initial numbers it had on the books with the European Union. Iceland and Dubai are the test studies for how the Europeans may deal with the idea of socializing private debt through public funding.

....

"I am seeing many sovereign defaults for the PIIGS as well as in Eastern Europe and the former Soviet satellite countries running into 2011," Chapman added.

Isn't it great to do things off-balance sheet? Why you can lie, cheat, and steal from investors, who believe you are far more credit-worthy than you really are.

Who else has done this?

There aren't any big American banks with a trillion or so (each) off balance sheet in SPVs, are there? Oh wait - there are!

America doesn't have somewhere around $80 trillion off balance sheet in Social Security and Medicare "promises", does it - nearly six times GDP? Oh wait - it does!

Why is this sort of thing a problem again?

IRA Goes Off The Rails - Mark To Market

nospam@example.com (Karl Denninger) — Sun, 07 Mar 2010 13:41:00 -0500

In what I can only describe as a self-serving piece for keeping banking "exactly as it is" (which is inherently unsustainable and thus can't be) IRA tries to refute the value of mark-to-market with a stunning piece.

Finally, on April 2, 2009, FASB allowed banks to use "cash flow" to value bonds when the market was illiquid - exactly like Bernanke said last week. This fixed the immediate problems in the system, and the economy and financial markets have been on the mend ever since. In fact, the stock market bottomed on March 9, 2009 - the very day markets found out that Representatives Barney Frank and Paul Kanjorski would hold a hearing to force FASB to change the misguided accounting policy.

No it didn't.

Remember FHLB Seattle again? Their "at market" losses on a portfolio of trash, er, loans was some $300 million. They claimed that the real loss to be realized over time was in fact $12 million, using model-based accounting. After all, these loans, while deeply underwater, weren't really impaired.

Or so they told Congress. I remember the testimony well.

But now, one year later, they are suing the banks that packaged up all this dog squeeze. Among the pieces of trash being sued over are the very same securities against which they said that a model-based valuation system showed a tiny $12 million loss.

Are they suing for $12 million?

No.

That "tiny $12 million loss" in fact is some $311 million - almost exactly what the market price predicted it would be.

Remember, this was in the "depths of hell" time period too - March of 2009. It was when the entire world was coming apart, Satan was chortling at the fate of our financial system and the S&P 500 traded - literally - at 666.

Yet that view - that market view - was correct.

To the regulators, it does not matter if the loan is still being paid on time. And it does not matter if the lower valuation of the collateral will force an already stressed borrower to come up with more cash. Regulators have decided that they want banks better capitalized and the way they can do that is to reduce the value of a bank's assets and then force these banks to raise money from shareholders.

It shouldn't matter to the regulators.

As I wrote months ago, the solution to this problem is One Dollar of Capital:

The solution is very simple, but you will notice that Jamie doesn't bring it up. That's because he finds it unacceptable.

What's that solution?

Prohibit as a matter of Federal Law, and enforce it vigorously under pain of immediately dissolution, THE LENDING OF MONEY UNSECURED THAT EXCEEDS THE FIRM'S CAPITAL.

This is in fact the only way you can both end "too big to fail" and not constrain size or influence.

It is also the definition of sound lending.

It is also how lending was done prior to the banksters corrupting the government and literally usurping the sovereign credit of The United States.

This is what the regulators are trying to back into.

It is the right thing to do, because it is the definition of sound banking.

ONE DOLLAR OF (EXCESS) CAPITAL FOR EACH DOLLAR OF UNSECURED LENDING.

You enforce this, the problem with systemic risk disappears. Banks can fail without harm to anyone else. Banks can take all the risk they want - with their shareholders and subordinate bondholders money - but never with depositors or secured bondholders money. At the point those bets go bad and deplete their excess capital the bank is closed - right then and there.

All secured lenders to the bank get their money back.

All of it.

All depositors get their money back.

All of it.

The shareholders and unsecured lenders to the bank take a haircut, which is determined by the actual over-time performance of the outstanding unsecured lending.

The FDIC Deposit Insurance Fund loss, if this regulatory framework is applied and enforced, is always zero.

This regulatory regime exactly matches the bank's lending risk with the expected risk of lending money to the bank. Those who lend unsecured (e.g. shareholders and subordinate bondholders) have lent money with the expectation that they might lose it. The bank in turn has lent out capital with the expectation that it might not be repaid.

The secured lenders to the bank - senior bondholders and depositors - lent their money with the expectation that it was a secured loan. The bank in turn lent that money out secured by an asset that is valued (each and every day) at or above the loan balance.

Statutory law sets a reserve ratio (cushion) between secured lending out and secured capital in. This gives the market room to move against the bank on the valuation of those secured loan assets without causing the bank to fail. Management is free to increase that ratio should it desire, but not to dip under it (if they do, the bank gets closed.)

But for each dollar of unsecured lending that is out there from the institution, that bank must hold one dollar of excess capital beyond statutory requirements.

If it does not, at any time, then the bank is closed, haircuts may happen, and the bank's management loses their jobs.

This is the only stable fractional lending system that can be constructed folks.

It remains difficult or impossible to find support for it precisely because it is so simple and yet it absolutely prevents the playing of "Heads Management Wins, Tails Taxpayers Lose."

If we want a stable financial system, we must impose this, and I call upon IRA, along with the other folks in the private and government sector, to wake up and smell the math.

Iceland: Now Finish The Job

nospam@example.com (Karl Denninger) — Sun, 07 Mar 2010 14:37:00 -0500

Iceland's voters took the first step toward the right thing:

Ninety-three percent voted against the so-called Icesave bill, according to preliminary results on national broadcaster RUV. Final results will be published today.

The next step would be to quash any talk of a "new accord."

There is exactly one accord to take: Tell the Netherlands and British to stick it.

They decided to step in on their own without the consent of the Iceland population when Iceland's version of the FDIC ran out of money. It was their decision, not the Icelandic people's to do so.

Voters rejected the bill because “ordinary people, farmers and fishermen, taxpayers, doctors, nurses, teachers, are being asked to shoulder through their taxes a burden that was created by irresponsible greedy bankers,” said President Olafur R. Grimsson, whose rejection of the bill resulted in the plebiscite, in a Bloomberg Television interview on March 5.

That's correct.

The people didn't cause the bankers to do the irresponsible things that led to this, just as the people in the US didn't cause our bankers to do so.

The bankers, with superior knowledge and all their grand mathematical models, took a bet.

The bet was that they could intentionally make bad loans and intentionally fail to disclose risks, and if the bet turned out poorly the people, who did not consent to be stooges, would bail them out.

Iceland's people have said no.

That should be the end of the discussion. The Netherlands and British should bear the costs - all of them - of their own decision to bail out their citizens. That decision was uniquely theirs and did not come with the consent of the Icelandic population - a consent that was belatedly sought and now has been overwhelmingly rejected.

That is the beginning and end of the discussion.

If that decision is not respected, and Iceland's parliament continues to try to subjugate the people to pay for an act they were not responsible for, then the people must rise and put a stop to it, in its entirety.

By whatever means are necessary.

To the people of Iceland:

You have my full and unwavering support. Do not knuckle under. These banksters - these criminals - attempted to steal your economic futures, dreams and hopes.

They intentionally and with malice aforethought put together financial programs they knew could not succeed in the long term, believing they could saddle you with the costs while keeping the benefits to themselves.

You have repudiated that belief.

You are a beacon of light in a world of darkness.

Now finish the job and send these jackals - these robber barons, brigands and thieves - packing. Eject them, and the ruin they bring, from your nation now and evermore, replacing them with sound, local, and accountable financial institutions that are not run for the sake of bubbles and cute mathematical models but rather on sound principles such as ONE DOLLAR OF CAPITAL.

May this vote be the start of an international citizen revolt - peaceful revolt - against the brigand-style fraud rained down upon the word by the pinstripe-wearing scam-meisters known as "banksters."

Oh, China Has Been Lying About Growth Too?

nospam@example.com (Karl Denninger) — Sun, 07 Mar 2010 14:18:00 -0500

Gee, who would have thought a communist dictatorship would pull something like President Obama has, but on a grander scale?

March 8 (Bloomberg) -- China plans to nullify all guarantees local governments have provided for loans taken by their financing vehicles as concerns about credit risks on such debt surges.

Ain't it grand to run a dictatorship? You can take a legal guarantee and nullify if with the wave of a hand.

Oh wait - Obama did that with GM and Chrysler too, didn't he? Hmm....

The Ministry of Finance will also ban all future guarantees by local governments and legislatures in rules that may be issued as soon as this month, Yan Qingmin, head of the banking regulator’s Shanghai branch, said in an interview. The ministry held meetings on the rules on Feb. 25 with regulators including the China Banking Regulatory Commission and the People’s Bank of China, Yan said March 5.

You mean "the great Chinese recovery" has been a scam? It was nothing of the sort, but instead was simple papering over the economic collapse with government-sanctioned borrow-and-spend without regard to ability to pay?

China’s local governments are raising funds through investment vehicles to circumvent regulations that prevent them from borrowing directly. A crackdown on local-government borrowing, estimated at about 24 trillion yuan ($3.5 trillion) by Northwestern University Professor Victor Shih, could trigger a “gigantic wave” of bad loans as projects are left without funding, Shih said this month.

$3.5 trillion of trash eh? Why that's about equal to our government's entire budget for a year, isn't it?

Wen also warned of “latent risks” in China’s banking system as he pledged to continue a moderately loose monetary policy and a proactive fiscal stance.

Moderately loose? You mean outright fraudulent lending is now "moderately loose"? Well then I guess our housing bubble and the bogus creation of securities wasn't loose at all, and China won't mind one bit if we tell them to stick their Fannie and Freddie paper (if they still have any) right up their tail.

See, the fraudulent credit creation isn't just a "capitalist" thing. It extends to communist dictatorships too.

Or is it that we're getting closer to them than they are to us in terms of how our governments actually operate?

One wonders.

All You Need To Know About Bank Balance-Sheet Fraud

nospam@example.com (Karl Denninger) — Sat, 06 Mar 2010 13:17:00 -0500

I am constantly amused by those people who claim there is some vast "conspiracy" in this country when it comes to banks, balance sheets, and fraudulent lending and accounting.

There is no conspiracy.

It is, in fact, "in your face" fraud.

The FDIC does us the courtesy of explaining it virtually every Friday night, right on their web page.

I am simply going to take last night's bank closures, which numbered four. One of them has no "deposit insurance fund" estimated loss available, because they didn't find someone to take the assets - they're just mailing checks. But the other three do.

Waterford Bank, Germantown MD: $155.6 million in assets, $156.4 in insured deposits. They were "underwater" by $800,000, right? Wrong: Estimated loss, $51 million. That is, the assets of $155.6 million were overvalued by approximately 30% at the time of seizure.
Bank of Illinois, Normal IL: $211.7 million in assets, $198.5 million in deposits. They were "underwater" by $13.2 million (which is why they were seized), right? Wrong: Estimated loss $53.7 million. That is, the the assets of $211.7 million were overvalued by more than 25% at the time of seizure.
Sun American Bank, Boca Raton FL: $535.7 million in assets (so they claimed anyway), $443.5 million in total deposits. Heh, why did you seize them - they have more assets than liabilities? Oh wait: Estimated loss: $103.8 million, so the actual assets are worth $443.5 - $103.8, or $339.7 million. That is, the assets of $535.7 million were overvalued by a whopping 37% at the time of seizure.

This isn't new, by the way. In August of 2009 I went through Colonial Bank's failure based on BB&T's presentation to its shareholders on the "merger" - and gift it was given by the FDIC. It too showed that Colonial had been carrying assets on their books at a ridiculous 37% above where BB&T ultimately marked them as a whole.

Folks, your bank is being assessed deposit insurance premiums to pay for these losses. You are paying these losses through increased fees and interest expense on your credit cards and all other manner of borrowing.

You are paying for outrageous, pernicious and endemic balance sheet fraud.

There is no conspiracy. It is right under your nose. One of these three banks, based on their balance sheet, wasn't even underwater - it was "to the good" by nearly $100 million dollars.

The balance sheet was a flat, bald-faced lie.

You want to sit for this?

Why should you?

Now let's ask the inconvenient question:

Are the big banks - specifically, Citibank, Bank of America, Wells Fargo and JP Morgan - all similarly overvaluing their assets?

Why should we believe they are not? You can go through more than a year's worth of FDIC bank seizure information and in essentially every single case you will find that overvaluations of somewhere from 20-50% have in fact occurred, yet not one indictment for book-cooking has issued.

So let's be generous and assume that the "big banks" are over-valuing their assets by 25% - the lower end of the range of what the FDIC says is, through actual experience, what's going on, and add it all up.

Bank of America shows $2.25 trillion in assets.

Citibank shows $1.89 trillion in assets.

JP Morgan/Chase shows $2.04 trillion in assets.

And Wells Fargo shows $1.31 trillion in assets.

This totals $7.49 trillion smackers.

The FDIC's experience with seizing banks thus far suggests quite strongly that all four of these entities are lying about these valuations, and that were they to be seized the loss embedded in them (and for which you, the taxpayer would be responsible) is somewhere between $1.49 and $2.99 trillion dollars.

Incidentally, neither the FDIC or Treasury happens to have either $1.49 or $2.99 trillion laying around, and it is highly questionable if they could raise it, should that become necessary.

Now of course neither you or I can prove this is correct. However, we can look at the FDIC's own published bank closing statements, and derive from them a pattern stretching back more than a year now that has disclosed that in essentially each and every case the banks in question have overvalued their assets by anywhere from 20-40%, and that as of the day of the seizure such an overvaluation was in fact a continuing and ongoing practice.

Back in the beginning of 2009 we had people argue that "mark to market" was invalid - that in fact the market-based pricing losses that were being claimed were ridiculous and would never happen. One of the claimants was the Federal Home Loan Bank of Seattle, which said that the $300 million in mark-to-market losses would not actually happen - that the real loss was only going to be $12 million dollars.

FHLB Seattle recently filed suit against the bundlers of this trash, claiming, surprise-surprise, that the real loss is not $12 million, not $300 million, but $311 million - on that bundle of trash alone. In all they are seeking $2 billion in damages.

We have now learned, a year into this "experiment" with mark-to-model promulgated at gunpoint by Congress that:

The banks indeed have been lying about asset valuation and the proof comes in the form of the FDIC seizures, which in essentially case have documented massive and outrageous overvaluation of assets on bank balance sheets.
The claimed "mark to model" losses, which were tiny compared to the market-price losses, were in fact fictions, to the point that the poster child of the "mark to model" argument is now suing the purveyors of the instruments supposedly not to be marked to the market for losses that exceed what the market-based loss was back in March of 2009.

If you wish to argue that the economy and banking system are recovering their health, you must deal with this. If indeed large bank balance sheets are concealing a deficiency of somewhere between $1.5 and $3 trillion in losses not only will the economy and lending environment not recover it can't as the large banks all know the truth.

I believe this is why those very same banks are hoarding cash. I believe they know that at some point in the future - a point not under their control - the truth may come out and if it does an instantaneous run would occur - not just on their bank, but on all banks. Such an event could be defended against only with a huge cash hoard - a hoard that, if they lend out said cash, would not be available to them.

The Federal Reserve knows this too. I believe this is why there is nearly $1 trillion of "excess reserves" sitting at The Fed, up from nearly zero prior to the crisis - it is these large banks' "backstop" against a potential run should the truth of their balance sheets reach public conscience.

The political and regulatory bottom line is simple: As I have repeatedly maintained for nearly three years, we now have the facts from our own government agencies, most particularly the FDIC: The banks have been and still are cooking their books in a manner that intentionally overstates their asset valuations - an act that is exactly identical to that which brought down ENRON.

Something to think about on this fine weekend.

Oh, The Cops Knew Too? (LMSD)

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 11:34:00 -0500

Now this is getting interesting; we appear to have a police department that has invited an 42 USC 1983 lawsuit:

The district even set up a secure Web site so the police could have access to pictures and other information, according to attorneys in the case.

"Quite honestly, the police knew about these devices," said Marc Neff, a lawyer representing Perbix. "They were not in the dark about the fact that these computers were being tracked."

Policemen don't have the authority to issue search warrants. Only judges have that authority.

Every person who, under color of any statute, ordinance, regulation, custom, or usage, of any State or Territory or the District of Columbia, subjects, or causes to be subjected, any citizen of the United States or other person within the jurisdiction thereof to the deprivation of any rights, privileges, or immunities secured by the Constitution and laws, shall be liable to the party injured in an action at law, suit in equity, or other proper proceeding for redress, except that in any action brought against a judicial officer for an act or omission taken in such officer’s judicial capacity, injunctive relief shall not be granted unless a declaratory decree was violated or declaratory relief was unavailable. For the purposes of this section, any Act of Congress applicable exclusively to the District of Columbia shall be considered to be a statute of the District of Columbia.

Good luck to the local police department - they may need it, along with the school district.

Active cooperation of the school and police department to violate 4th Amendment rights against searches without a warrant having issued is a potentially-huge problem.

It's bad enough when the school attempts to arrogate to itself the right to search your home.

It's even worse when they conspire with the local cop shop and "don't bother" to get a judge involved to sign a search warrant.

Never mind the school who tried to claim originally that this was "just a little IT thing" used for internal purposes to find stolen laptops. Now we discover that the cops had their own little backdoor into the spying system, courtesy of the school administration and IT department, all used without lawful search warrants.

Hint to the lawyers: Sometimes it's better to keep your mouths shut.

Yeah, This Will Work Out Fine (Budget)

nospam@example.com (Karl Denninger) — Sat, 06 Mar 2010 12:00:00 -0500

*CBO SAYS DEFICIT THIS YEAR TO AMOUNT TO $1.5 TRILLION
*CBO SAYS PUBLICLY HELD DEBT TO GROW TO 90% OF GDP BY 2020
*CBO SAYS OBAMA BUDGET WOULD PRODUCE $9.76 TRILLION IN DEFICITS

Not a snowball's chance in hell we get to 2020 doing this.

Oh, that's $1.4 trillion more than their last guess, mostly on lower tax collections (no really?)

Here's the problem with this new CBO number - it more than doubles the public Treasury debt float over the next nine years.

It also "predicts" that China and other investors will increase their holdings of US Government debt from their current $7.5 trillion (the current marketable paper) to $20.3 trillion by 2020. And under the CBO's optimistic view, interest payments would "only" quadruple, to some $900 billion annually.

Yet if GDP rises at a compound rate of 4% for the entire ten year period (no more recessions!) the tax base upon which to assess taxes to pay that quadrupled interest expense will expand by only 48%.

Best-a-luck on this one folks - we won't make it to 2020 on that trajectory before someone who has done the math (we're talking basic math here too folks, not grad school stuff) calls BS on this one.

Heh, I Tawt I Taw A Jumpsuit!

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 14:37:00 -0500

I did, I did tee a jumpsuit!

TUSCALOOSA, Ala.—Former Birmingham Mayor Larry Langford was sentenced Friday to 15 years in federal prison for taking some $235,000 in bribes in return for lucrative bond work.

But investment banker Bill Blount pleaded guilty to making the payments, and lobbyist Al LaPierre admitted being the middleman. Mr. Blount, the former state Democratic Party chairman, last week was sentenced to more than four years in prison. Mr. LaPierre, the former executive director of the state Democratic Party, got four years. Mr. Blount also was ordered to pay $1 million to the government, and LaPierre $470,000.

Wait a second....

How come Blount and LaPierre only got four years?

And how much did these guys - and these banks - get?

Mr. Langford was accused of telling major Wall Street banks J.P. Morgan Chase & Co., Goldman Sachs Group Inc., Bank of America Corp. and the now-bankrupt Lehman Brothers to include Blount's investment banking firm if they wanted to handle the county's bond work.

They just got sued, right?

Yep.

Just a "cost of doing business"?

Kinda like Pfizer and the Federal Reserve Board of NY?

No wonder these banksters keep at this crap - we prosecute and lock up the people they screw around with, but the banks themselves, just like the big drug companies, get fined in tiny amounts that amount to one percent or less of their market cap.

Yeah, that's a deterrent against criminality.

Assuming Barney Frank Is Not Lying....

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 12:44:00 -0500

... about fixing housing finance through a completely redesigned system instead of trying to "fix" Fannie and Freddie (I know, believing a politician is not lying is always dangerous) I offer up the following suggestions.

Put Fannie and Freddie into run-off via formal receivership. Leave them outside of the government and withdraw all support. Whatever the RMBS return, they do. Whatever the bondholders get back, they do. No support. The face of the prospectus was clear and everyone, including Bernanke, knew it. Honesty and fair dealing starts with telling the truth.
Leave the mortgage market alone for 90%+ of the transactions. That is, no government involvement whatsoever.
With that said, there are two places I recognize a reasonable place for the government to get involved. The one I cannot argue against is the VA mortgage program - I believe this is a perfectly-legitimate benefit of military service and should be maintained. The other is for very specific and targeted FHA loans for low-priced housing. Both should be limited to homes in the lowest quartile of price irrespective of location, that is, with no "escalator" for "high priced" areas. We live in a nation with freedom of movement and association - if you find the place you're living in to be too high cost, then move!

However, if we're going to leave FHA and VA loans in place (and we can do the issuance via Ginnie Mae, which already exists) we need to seriously restore underwriting standards. Specifically, the following are minimums I believe we must demand:

NO automated underwriting and no use of FICO scores at all. FICO is not useful for longer-term obligations, which a mortgage is. Instead, all files must be manually underwritten.
28% front-end ratio and 36% back end (DTI) ratios must be enforced. No exceptions, no ifs, ands, buts or maybes. High-ratio loans are still being made and they're the #1 reason why these loans default. This has to stop.
No VA or FHA refinances permitted for cash-out, without exception. If someone wants a cash-out loan they need to get it on the private market.
10% down payments in cash required, seasoned funds. No kickbacks, no funny games, no seller funding, no "loans from Dad." Cash means cash. If you can't come up with it you don't need to own a house. This isn't being cruel - it's being honest. Roofs needs repair (I'm putting one on my place this spring), water heaters leak and need to be replaced, things deteriorate over time or simply break. You have to be able to save up enough money so that you're not dependent on credit cards if and when something like this happens.

Task the DOJ with enforcement of all statements on mortgage loan applications and paperwork. You lie, you go to prison. Period. End of discussion. No more "fraud for housing" .vs. "fraud for profit" - fraud is fraud, you go meet Bubba and lose your house. Investors have to be able to fairly evaluate what they're buying and so does the government!

In the private market I would radically revamp the securitization system such that:

Any bank that securitizes debt cannot offload liability for breached reps and warranties. You issue it, what you represent and warrant is in the package is yours, without exception or disclaimer.
Credit derivatives on RMBS are absolutely banned (thereby preventing the formation of synthetic CDOs that are purposeful value destroyers by hedge funds and others.) Any true hedge + the underlying (if the hedge can perform) will return less than a Treasury of similar characteristics - as such it makes no sense at all to buy such a thing except to perform regulatory arbitrage, which must be prevented to stop future financial market disasters.
All off-balance sheet, "Level 3" or other-than-marked to the market "holding pens" for such vehicles are banned. If you want to hold these assets you have to do it where people can see them, without exception. That is, it's perfectly ok for investors to buy these for investment purposes but the practice of using them as speculative trading vehicles in hinky legal structures has to be stopped.

That would be a good start.

PS: As I write this the pumptastic CNBS crooners claim that Barney Frank has repudiated his statements. Even though he apparently made them originally in public.

Mr. Frank, did you truly wake up and decide to do the right thing or not? I think you owe everyone an answer.

Kaaaaaaaa...... BOOM! (Fannie/Freddie)

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 11:59:00 -0500

Now this is interesting...

March 5 (Bloomberg) -- Fannie Mae and Freddie Mac bondholders shouldn’t assume the government will make them whole on their investments as Congress retools the companies, House Financial Services Committee Chairman Barney Frank said.

Heh, who's the biggest individual bondholder?

Mr. Bernanke, the bond market is on line #1!

Frank continues:

A “whole range” of options is being considered for investors in the two government-seized companies, “from paying nothing to a haircut to whatever,” said Frank, whose committee oversees Fannie Mae and Freddie Mac.

Nothing? You mean zero, zilch, bupkis?

That would be rich. After Bernanke stepped in and bought some $200 billion of their debt, to have it "marked to zero" would be the ultimate slap in The Fed's face for buying that which I have argued is impermissible under the law.

What an elegant solution to a difficult problem - "oops - tear 'em up jackass - you should have known better than to buy something that you weren't allowed to and was patently worthless!"

The irony of that outcome would be delicious. Yes, I know I'm dreaming here - or am I?

“Please don’t think this is federally guaranteed, I don’t think it is, I don’t think it should be, I don’t feel any obligation to bail you out,” Frank said. Congress will “certainly not” extend any new protections to bond and mortgage-security investors beyond what exists, Frank said.

Oh. You mean that the face of those prospectuses mean what they say? You mean this is real?

Uh, the market is kinda ignoring that right now, isn't it?

Yes, I think it is.

How about this for a clear statement?

“We’re not remaking Fannie and Freddie,” Frank said. “We’re going to start from scratch and do housing finance.”

Go ahead folks, keep buying. This is spelled "opportunity", thank you very much. Now please excuse me while I go put a few chips on "red."

PS: Why are these stocks still listed again?

Buy Financials (Because I Was Right)

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 10:06:00 -0500

Yes, that's sarcasm:

The mortgage firms are looking at every loan more than 90 days past due and “asking us basically to give them all the documentation to show that it was properly underwritten,” JPMorgan’s Scharf said. “We then go through a process with them that takes a period of time, and literally it’s every loan, loan-by-loan, and have the discussion on whether or not we actually should buy the loan back.”

That's exactly what I said would happen more than two years ago.

EVERY LOAN.

If there was appraisal fraud OR

If there was income fraud OR

If there was DTI fraud OR

If the automated underwriting was gamed OR

If there was asset fraud

THEN the bank gets rammed with a repurchase demand on the bad paper - paper that is 90 days+ and, in essentially every case, dramatically underwater.

The "dream" that this will result in "only" $7 billion in losses (30% of the repurchased amount) is a fantasy.

The most common include inflated appraisals or falsely stated incomes in the loan applications, said Larry Platt, a Washington-based partner at law firm K&L Gates LLP who specializes in mortgage-purchase agreements. The government agencies hire their own reviewers who go back and compare the appraisals with prices from historical home sales, he said.

Ding ding ding ding ding ding.

The truly ugly news isn't found in these mortgages. It is found in the second lines - HELOCs and "Silent Seconds" - that are behind these agency mortgages. Those are worth zero once the first defaults, and when the repurchase demand is perfected the auditors are going to force these loans to be recorded at their likely recovery value - which is zero.

There are literal hundreds of billions of dollars worth of that trash on all of the big banks balance sheets, and all of it is being carried under assumptions that nearly every one of those loans is "money good." 80% of the dollar value of these HELOCs and Seconds are in the bubble areas and of those virtually all are behind an underwater first.

The assumption that these loans are "money good" is blatantly and intentionally false. It is a fiction that our regulators, examiners and auditors have foisted upon the public, and if you rely on it, you will get burned.

Oh, JP Morgan's net income for all of 2009? $11.7 billion.

They recorded $1.6 billion last year for this "expense", and I'm willing to bet that it's double that or more for the coming year, not to mention the impairment or outright write-off of the seconds.

That would be roughly 20% of their net earnings - not exactly an immaterial amount of money.

PS: $21 billion is tiny compared to the tsunami headed these folks' direction. In the end every piece of this bad paper is going to head back to the securitizers and originators. All of it - and the seconds behind that paper are all going to wind up marked to zero, because they are subordinate to an underwater first. It is simply a matter of time before the people who hold these RMBS and the more complex securities structured on top of them decide to come after the banks and, to the extent that they can prove malfeasance or misfeasance, these banks will eat it.

Oh, The Left-Wing Nutjobs Shoot Too?

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 09:44:00 -0500

Hmmmm....

Resentment of the U.S. government and suspicions over the 9/11 attacks have surfaced in writings by the Californian identified as the gunman who shot two Pentagon police officers before he was mortally wounded in a hail of return fire.

Oh, that's not a right-wing thing - that's a lefty paradise! Specifically:

Signs emerged that Bedell harbored ill feelings toward the government and the armed forces, and had questioned the circumstances behind the Sept. 11, 2001, terrorist attacks.

The user named JPatrickBedell wrote the Sabow case was "a step toward establishing the truth of events such as the September 11 demolitions."

Demolitions eh?

Ah, a 9/11 Troofer. Got it.

The mark of the hard left, who are convinced that Dick Cheney ordered the towers blown up with explosives as a way to goad the United States into invading Iraq - all for that evil Texas Tea, of course.

I wonder how long it will be before we see the bastions of the left in the mainstream media call this what it is - home-grown terrorism conducted under the banner of the "troofer" who are convinced that our government killed 3,000 of our own citizens on 9/11.

"What is never, Alex."

Such intellectual honesty you have, Mr. Media Man.

Employment Situation: Welcome To Census Temp Jobs

nospam@example.com (Karl Denninger) — Fri, 05 Mar 2010 09:07:00 -0500

And hereeeeeeeeeees..... CENSUS!

In February, employment in the federal government edged up. The hiring of 15,000 temporary workers for Census 2010 was partially offset by a decline in U.S. Postal Service employment.

Yep.

Headline number was -35,000 and the unemployment rate held at 9.7%, both headline. Everyone's fear of a huge weather impact was instantly dashed, as the BLS said they couldn't quantify any changes in their sampling "accuracy." Given their methodology the most-likely place for any real impact to show up is in the hours worked, not the actual employment rate, and that did tick down by a tenth.

The internals in the household survey, however, showed real improvement.

Unfortunately we're nowhere near the 200,000 or so net job adds that we need to find in order to cover new entrants to the workforce, but these tables are a marked improvement over the previous months:

Essentially flat-lined. That's good, actually, off the household numbers.

Ah, that's where it came from. Essentially all of the "improvement" in the monthly household data came from those formerly leaving the labor force coming back in.

That is, there was no net hiring of new entrants to the labor force, but the insane rate of "drops" reversed and some of those who were discouraged re-entered the workforce. And indeed, if you look at the U-6 number you'll see that not-seasonally-adjusted it fell from 18.0 to 17.9. Note that on a seasonal adjusted basis BLS claims that the U-6 rate increased by three tenths (to 16.8 from 16.5), which is curious and implies that the seasonal expectation is for a big rise in shift out of "not-in-labor force" and other "marginally attached" people - and they didn't get it.

Interestingly enough if you look at the previous years monthly numbers do show a significant spike in this month. Is the BLS overly pessimistic with their seasonal adjustments or are we seeing a real turn? No idea - yet - but seasonal adjustments won't account for Census temporary hiring, which will continue through the spring (and then result in firing come summer!)

Everyone (myself included) expected census hiring to be significnat, and it is. The release of the data caused an immediate spike upward of a few points in the futures, but it also hammered the ten year Treasury rate (upward.)

The key is sustainability, and unfortunately the census employment will skew this in a way that is going to be extremely difficult to back out until the summer months when it ends and those people are laid off. If that hiring and the pay disbursed as a consequence produces a significant upward swing in spending, there could be a salutary knock-on effect in the private sector. But that's a big if, as it requirs that those people employed by the Census spend the money instead of paying down debt and deleverage their personal balance sheets.

All-in the report is a definite positive but right in line with expectations, given government activity. My short-term concern is the offsets from announced job actions in various state and local governments as they attempt to avoid their own insolvency, balanced by the Census activity.

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.

GMAC Co-Mingling Custodial Funds?!

nospam@example.com (Karl Denninger) — Thu, 04 Mar 2010 15:56:00 -0500

What's this crap?

The rating company said GMAC commingled cash flows from multiple bonds in a single custodial account, Moody's said in a statement. This allowed GMAC to use cash from loans in one bond for principal and interest payments on another, it said.

By allowing the commingling, it "increases the likelihood that some RMBS deals may not be able to recover the amounts 'borrowed' by the servicer to fund advances or another RMBS deal if a servicer bankruptcy were to occur," Moody's said.

What?

Is that permitted? Legal?

When is a servicer not a fiduciary (effectively, a trustee) for the bondholder? It appears the answer, in this case, is whenever they feel like shuffling around funds and paying one bondholder with money that came in from a different deal.

Oh, we bailed them out too.

Several times.

So far.

Next question: Who else is doing this sort of thing? Or maybe the better question is "who's not doing this sort of thing?" The latter may be the shorter list.

How's this for "undisclosed risks"?

So Much For Universal Default Disappearing

nospam@example.com (Karl Denninger) — Thu, 04 Mar 2010 11:31:00 -0500

Gee, how do you like the rape job that the banks just served up on you?

(Click to enlarge)

Read that white part carefully, and then make sure you read the inverted part.

If you:

Exceed your credit line.
Do not pay on time (even once)
The bank believes you will be either unwilling or unable to pay because of "information they receive" (like, for instance, because your credit report discloses you didn't pay someone else?)

The bank can immediately close your account without notice AND DEMAND YOU PAY THE ENTIRE BALANCE ON THE ACCOUNT IMMEDIATELY.

Oh, and when you can't (because you thought you had time to pay) you are then in default again for not paying "on time" and they can sue and add attorneys fees and costs.

I thought this crap was going away?

This, by the way, is from Chase, I have the entire section of the statement (all pages), and is claimed to be effective on 22 February.

So much for the CARD act banning practices like this, eh?

This is effectively a "CALL" option on your credit card. This "feature" is why when I ran MCSNet I refused to ever accept a bank credit line for any purpose whatsoever for the company - they all had this sort of tricky crap in them somewhere. Every one. In each and every case such a clause gives the bank the right to force you into bankruptcy if you ever actually use the credit for anything other than as a cash-management tool (that is, as a means to pay for something over time), as they can declare the line in default any time they'd like and accelerate repayment, demanding the full balance. You either have it (in which case you didn't really need the credit, right?) or you're bankrupt - at their sole discretion.

TELL THE BANKSTERS TO SHOVE THIS CRAP UP THEIR BUTTS - WITHDRAW YOUR MONEY AND REMOVE YOUR BUSINESS FROM ANY LENDER WHO HAS SOMETHING LIKE THIS IN THEIR AGREEMENTS - ALL OF IT.

I warned people a year ago to get out of debt, especially revolving debt or any other sort of credit where the terms could be changed on you, in my "Ten Things" Ticker of June 8th of 2009.

This sort of trick is why.

It's Called DEFLATION Folks

nospam@example.com (Karl Denninger) — Thu, 04 Mar 2010 09:59:00 -0500

Never mind the man behind the curtain, who won't utter the word:

The Labor Department reported Thursday that productivity jumped at an annual rate of 6.9 percent in the fourth quarter, even better than an initial estimate of a 6.2 percent growth rate. Unit labor costs fell at a rate of 5.9 percent, a bigger drop than the 4.4 percent decline initially estimated.

In the real world this means:

Work harder and get more done.
Get paid less.
Suck it up, don't complain, or you're fired.

That's all.

And by the way, reduced pay per unit of work spells DEFLATION.

Now here's the problem: We have huge public-sector labor unions that are resisting this force. Yet this force is exactly what has to happen in order to bring the economy back into balance.

We have "advanced" promises made to these people - $200,000+ pensions and other similar obscenities - even though doing so is a ponzi scheme that is impossible to maintain. We have continually cow-towed and pandered to these unions, including educators, police and fire and all other manner of public sector employees with wage increases that exceed growth in aggregate output per-person when one counts both salary and benefits.

This, of course, cannot continue. It is yet another example of the expanding gap that opens up between two exponential functions - for those who have forgotten my favorite pair chart (two exponential curves, one with a slightly-higher exponent than the other), here it is again:

I understand that everyone wants to avoid taking the pain. I understand that everyone claims that "its not fair!"

None of this changes the facts. You cannot continually offshore your better-paying labor to China for the purpose of being able to have a $30 DVD player, destroying the $40/hour skilled job base and replacing it with $7/hour burger flippers and espresso-shot-pullers, and maintain the ability to commit compound annual growth rates of 5, 6, 7% or more to public-sector employees. Doing so inevitably destroys the tax base necessary to meet those commitments, and once the destruction has occurred it cannot be un-done.

You cannot falsely-report "growth" that is in fact no such thing, but rather is simply the addition of more debt, thereby creating false demand that never existed on an organic basis, and continue this process forever.

The person who loses their job can continue to spend as if they have not - for a while. They can run up the credit cards - for a while.

They can do so until the credit card company discerns that the ex-employee has no money, and thus will never pay them. Once that happens the credit card is cut off.

States, municipalities and nations are no different than people in this regard. We have played this game for 30 years. We have promised people they could have unlimited health care, unlimited prescription drugs and unlimited, compound increases in salaries and benefits. At the same time we have permitted our corporations to send their labor base overseas, destroying the income base to purchase these products and the tax base required to pay those benefits. All of this has been "facilitated" by a financial system that grew from about 7% of the marketplace to well north of 20% (in 2007) before it all fell apart.

Instead of allowing it to fall apart and return to a 5-7% of the market, which would be sustainable, politicians instead created false final demand of about 9% of GDP (~ $1.2 trillion annual increases in deficits on a $14t GDP) and then added $13 trillion of "guarantees" in the form of funny money to the financial system to prevent it from imploding (roughly equal to the entire financial debt in the system, which currently stands around $16 trillion.) This "prevented" the immediate recognition that the derivatives written by these firms were nothing more or less than a gigantic fraud, as there was no ability to pay - not at origination, not at maturity, not ever.

But none of this game-playing changes the mathematical fact that:

The money to pay these bets never existed, and never will. It was a fraud, but our politicians refuse to direct law enforcement (which reports to them) to enforce the law against fraud, as that would "hurt" their campaign donors (they'd go to jail!)
The offshoring of our production has destroyed both incomes and the tax base. "Replacing" that with more borrowing is exactly identical to an unemployed person using their credit card to maintain their standard of living. It will fail - we are simply arguing over when, not if.
Public sector employees are inherently parasites. It cannot be otherwise. The policeman, fireman and teacher do not directly produce anything. Their employment and the wages and benefits they can collect must therefore inexorably track the actual productive output of the nation.
Finance in all it's forms, whether banking or insurance - produces nothing either. Every dollar of such "activity" comes about only as a parasitic drain on production. It cannot be otherwise. Further, speculative activity in all of its forms produces losers in exact proportion to winners - if Goldman makes $100 million speculating on oil prices, someone else loses the same $100 million. The net benefit to our nation's economy? Zero - we merely moved money from one hand to another.

The actual private sector production worker is now being forced to recognize this. He's being told to work harder and longer for less money (per hour) or lose his job. That's what the statistics say. This sort of movement in the private labor force is unprecedented - it in fact exceeds that which formerly was accomplished with computerization in the 1980s and 1990s - and this time it's actual labor, not the introduction of new technology.

The first step to solving problems is admitting to what they truly are.

The recent pronouncements and announcements out of both the new governor of New Jersey but also California, where they have attempted to play "extend, pretend and charge-it-up" more and worse than anywhere else in the nation make clear that the credit line has run out and we either face the facts - like it or not - or we get the clue-by-four upside the face.

As usual, the politicians thought they could extend, pretend and lie until after the election. As in 2008, they're wrong, and if they don't cut it out we'll get a repeat of the 2008 disaster but this time around it will be much worse.

Welcome to 2010.

Janet Hits It Out Of The Park (Again)

nospam@example.com (Karl Denninger) — Thu, 04 Mar 2010 11:18:06 -0500

In Huffington Post.....

Wall Street got bonuses, taxpayers paid the bill, America got a deep recession, and the world got the worst financial crisis in history. Financial holocaust deniers obstruct solutions that can help prevent the next crisis and would stick taxpayers with the bill again.

Yep.... listen to the shills try to deflect the voice of reason....

Disgusting, isn't it?

Tell their advertisers what you think. It's the only way to be sure....

Greece Gets Told To Bite It

nospam@example.com (Karl Denninger) — Thu, 04 Mar 2010 08:12:00 -0500

Greece is now whining that their "austerity" should bring gifts - from Germany:

“We have fulfilled to the utmost all that we must from our side; now it’s Europe’s turn,” Papandreou told his ministers, according to an e-mailed transcript. “It is a historic moment for the European Union.”

No it's not.

Honest accounting is its own reward. So is fiscal prudence.

You're owed nothing Greece.

More importantly, there's no money. Not just there - here too. Witness the layoff/hirebacks in California and New Jersey's new governor - the latter who told the truth for the first time by a state politician in 30 years.

You wouldn't know it from the pumper brigade on Tout TV, of course. They claim it's all getting better.

Really?

Borrowing and spending 9% of GDP by the government to falsely inflate final demand is "getting better"?

No, it's hiding the truth, and while it can continue for a while, just as you can do the same thing if you lose your job, continuing to run up your plastic until your credit card company figures out that you lose your job and will never pay them back, so can governments.

Unfortunately instead of solving the problems in our economy and financial system - which would have resulted in the bankruptcy of some very powerful people and firms - we decided to lie.

Just like Greece, just like Italy, just like the rest of the world.

Politicians are very good liars. Indeed, it's pretty much all they do.

But irrespective of how much you want to lie, or how much you do lie, at the end of the day when there is no money left what your "balance sheet" says you have is immaterial.

Only cash pays the light bill my friends, and the cash is insufficient to cover the demands of those who want to suck on that government tit.

This is math - not politics.

Now Seniors Get To Feel The Bezzle

nospam@example.com (Karl Denninger) — Thu, 04 Mar 2010 07:58:00 -0500

If you remember just a short while ago I reported on what certainly appears to be a very clumsy scam pulled by the BLS in their so-called "inflation" reading published on the 19th of February - where the numbers they presented simply didn't add up, and as a consequence put forward a false CPI, or inflation number.

Curiously, we haven't heard anything from the BLS on this "error".

This, of course, is only an "error" in that it is not the actual means by which the BLS is "supposed" to report "inflation."

But the BLS has twice in the last 30 years revised their methodology, both times with the intent of understating "inflation."

Why? Well, a big part of the reason is that the law says that various benefit programs are supposed to be indexed to inflation. By intentionally understating inflation Senior Citizens and others on various fixed-income entitlement programs funded by government get intentionally screwed.

The Senate yesterday rejected a $250 one-time check to Seniors and others who have been so-screwed for the last two decades:

President Barack Obama has called for Congress to approve the payments to make up for their benefits not increasing this year, but the Senate defeated it 50 to 47.

....

Social Security payments for the elderly and disabled will stay flat this year for the first time since 1975 because they are tied to consumer prices, which decreased amid the worst economic recession in 70 years.

Of course the real problem doesn't lie here. As is usually the case the media won't talk about the fact that the current inflation rate, if measured under the "old" methodology, never went anywhere near zero.

How much does this "count"? Tremendously so. Over a ten year time frame understating inflation by 7% results in your Social Security payments being half of what they would otherwise be. If the understatement is by just 3% you get a 35% underpayment at the end of a ten year period.

Of course what the media reports is the "one time" payment was rejected, but what they don't report is that seniors have been screwed for three decades by intentional book-cooking in the government.

And by the way - no, there is no possibility of the government "fixing this" and paying what the law says they should. The money doesn't exist.

But this scam, along with dozens of others, is how our fabulous government managed to run its Ponzi Scheme for as long as it has - a Ponzi that is now collapsing, irrespective of what you're being told by the vacuous bobbing heads on national television.

If you're a senior and been paying "membership dues" to AARP, you might want to ask them why their much-vaunted "lobbying" and "public education" campaigns haven't focused on this for the previous 20 years - and why they sold you down the river.

Hope you like your kids (and they like you) Seniors, because the government tit is rapidly running dry.

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.

Spain: Calling The Whaaaaambulance!

nospam@example.com (Karl Denninger) — Wed, 03 Mar 2010 15:12:00 -0500

This is rich....

BRUSSELS, March 3 (Reuters) - Spain wants the European Union to use a planned public prosecutor's office for the region to protect the euro currency against speculators, Spanish attorney general Candido Conde-Pumpido said on Wednesday.

Do the prosecutors have a mandate to go after all the nations - perhaps including Spain - that cooked their books?

Why do I already know the answer to that question....

"Doubtless if there were a public prosecutor and there was a combined attack against the single currency, the prosecutor could coordinate the legal response vis-a-vis that attack."

Doubtless: Up yours. Stop lying and the problem won't present itself.

Oh wait - that would mean you'd have to close a bunch of your big banks, right? Care to return the AIG pass-through payments?

That's crickets I hear, crickets....

Microsoft: Blow Me

nospam@example.com (Karl Denninger) — Wed, 03 Mar 2010 14:23:56 -0500

Now this is hubris:

Today most hacked PCs run Microsoft's Windows operating system, and the company has invested millions in trying to fight the problem.

That's because the operating system was designed for backward compatibility with Windows 95 and 98 first (and 3.1 before it) which had no concept of permissions or privileges. It was (until Windows 7) thus inherently insecure and even Vista (and Win7) can be told to be insecure to deal with all those "legacy issues."

In short, these machines are infested (not infected, infested) because their operating system has historically been full of security holes (this has improved, especially in Windows 7, to be fair.)

So what does Microsoft propose?

So who would foot the bill? "Maybe markets will make it work," Charney said. But an Internet usage tax might be the way to go. "You could say it's a public safety issue and do it with general taxation," he said.

That's nice.

Sell an insecure operating system and then get someone else to pay a tax because they bought an arguably-defective product you sold?

How about this instead Microsoft?

For each computer infested, the publisher of the operating system sold to that user is assessed a fine of US $100,000 by the Department of Justice.

I bet that would get you to improve security quite a bit - or bankrupt your ass.

PS: Total number of viruses and other malware found on my rather-high-profile Freebsd servers in the last ten years? ZERO. Put that in your pipe and smoke it sir.

Medivation: Insider Trading Or Not?

nospam@example.com (Karl Denninger) — Wed, 03 Mar 2010 14:19:00 -0500

Medivation, if you've been under a rock this morning, announced bad results for an Alzheimer's drug (which Pfizer was involved with as well) and was destroyed this morning to the tune of 70%:

A quick check of option transactions yesterday shows that a lot of people were placing bets. Zerohedge put forward the premise (as did Livevol) that there was massive insider trading.

Maybe.

But it was Livevol's time & sales report that caught my attention. Specifically:

This sure smells bad. But that it was a spread does not necessarily mean that the trade was taken on inside information. Indeed, it might mean the opposite.

Consider that if both positions were sold then the trader got $14 + $17.50 = $31.50 per contract, assuming a 1x1. It actually looks like, however, a 1x2 (2x PUTs) with about 8,000 calls and twice as many PUTs.

So how does the trader win or lose?

Let's plot it out, assuming these contracts were sold:

This actually looks like a fairly reasonable trade going into a binary event like this. It loses under $13 or over $79, roughly, and makes the maximum profit at $40, with a couple of weeks to go. Yes, it has the potential to make $30 million smackers, which sure isn't shabby!

As of right now, with the stock trading $13.21 (as I wrote this), the trade is profitable - barely.

Insider trading or smart trading? Heh, that's a pretty good range! Even if the drug had hit, would it really have spiked up over $78 - and on a miss under $13?

Well, the trader probably thought not. So far he's right.

But a quick analysis of this trade doesn't appear to show a clear directional bias, which would have, given the money involved, been pretty clear evidence of inside information. Indeed, the "centroid" of the spread was right near the closing price yesterday.

This looks like a probability trade to me, which is exactly what you want to do when there's a news event and you think the options are rich at their implied volatility given what you think is going to happen. Indeed, I remember the Dendreon (DNDN) AC decision a couple of years ago during which I was doing spread trades like a madman, and made some nice coin doing it. I no more knew anything about the outcome of the AC than did the man in the moon but I saw an opportunity with a complex option spread and put it on. As the trade I put on had a defined risk I figured out how much I was willing to lose and stuffed size on as the decision approached - it sure looked big, but the net exposure, when it was all said and done, was reasonable.

I'm the first one to jump on an insider-trading scam if I see one, but this time, without more information to make me suspicious, I don't.

Disclosure: No, that trade wasn't mine - no position.
Disclosure #2: Nice analysis software eh? ThinkOrSwim folks. Really. And no, they don't pay me to say that :)

We're Schizoid! (Non-Manufacturing ISM)

nospam@example.com (Karl Denninger) — Wed, 03 Mar 2010 11:08:00 -0500

The latest non-manufacturing ISM is out, and schizoid is the best word I can use to describe it. Here's the table, appropriately highlighted:

Activity and production slowed its rate of acceleration slightly. New orders, however, accelerated a bit from their former "above replacement" rate.

The amusing part is that inventories are being drawn down, which is congruent with this. So all is right with the world, right?

Well, no. Inventory sentiment is that there's still too much inventory in the system.

So non-manufacturing (services) businesses are advancing order and production activity, while at the same time they think they have too much in inventory.

Uh......

In addition on the manufacturing side the current month showed deterioration both in production and new orders, and a SLOWING rate of change in inventory draw (instead of a quickening one.)

Uh, yeah.

Schizoid we be, trying to figure out whether we're actually going to see real final demand show up or if, as I have maintained for the last year, this is all a chimera of government borrow-and-spend - a chimera that is soon to come to an end and stick producers with huge amounts of unmarketable inventory.

CNBS' Kudlow and the rest of the "financial media" are desperate to get you to believe it's not the second. That "demand" - organic demand - is improving. This despite the raw mathematical fact that between Fiscal 2009 and Fiscal 2010 we're going to spend $3.1 trillion more than the government takes in, which incidentally is about $2.7 trillion more than was being "overspent" before the collapse. Put another way, that is about 10% of GDP which is not actual final demand but instead is comprised of the government borrowing money and showering it on the economy.

Ben Bernanke's helicopter? Nope - try Nancy Pelosi, Harry Reid and President Obama, and let's not forget that there is a sizable percentage of the population that not only believes that "President Obama is gonna pay my mortgage!" now, but that he'll continue to do so - and that he can continue to do so - forevermore.

Uh huh.

On that point, incidentally, don't talk to people in government contracting. I am hearing repeated reports of major shifts coming after the end of the quarter - that is, March 31st.

The Tinfoil brigage is out in force on this, claiming that we're about to have a "catastrophic" forced dollar devaluation. If that happens I'll eat my Wall Street Journal (part of a page anyway) on webcam for you all.

No, what's coming folks is major cutbacks in government budgeting, and it's not voluntary. Folks are putting in commitments on the current fiscal year to spend NOW rather than into the 3rd and 4th fiscal quarters.

This is normal coming into September 30th because of how the government does things. If you don't spend all of your budget, that which you "didn't need" will be stolen back for the next fiscal year. Thus there is always a mad rush to commit funds before the end of the Federal Fiscal year - always.

For this to happen now, with an end-of-second-quarter deadline, means that the government foresees either a major realignment of budgetary spending (and everyone is thus protecting claimed budgets by spending them NOW lest they be clawed back for other purposes) or worse, they foresee a problem with the bond market.

This also feeds into the manic desire to pass "health care reform" now, even though there will be no benefits to you, even as claimed by government, until 2013 - but the tax increases will start right now. The truth is that the "benefits" will come never and this entire "plan" is simply a scam to try to scare up more revenue that the federal government desperately needs, as the tax receipt numbers have absolutely gone through the floor.

You hope we don't get a bond-market blowup folks.

Really.

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.

NOW Congress Wants To Investigate? (Greek Swaps)

nospam@example.com (Karl Denninger) — Tue, 02 Mar 2010 13:23:00 -0500

Gee, how come all this didn't happen a year ago - or two?

“News has surfaced that investment banks based in the United States have funded firms that created the financial indexes and other information needed to trade against the possibility of a sovereign default overseas—after selling debt to those countries in a way that kept that debt secret from the public,” Rep. Maloney said. “These reports, if true, are a shocking echo of the financial crisis that faced the U.S. in 2008—whose reverberations are still being felt today, in the worst recession in decades.”

No really?

You mean just like those wonderful "CDOs" that Goldman (and others) created that were in fact fully synthetic instruments and which came into being ONLY because someone wanted to SHORT your house?

Exactly why weren't these instruments banned when traded "in the dark"?

Off-balance sheet? ENRON didn't make clear what happens when people hide things? After all, nobody ever hides good news, right?

Carolyn, it's nice to hear you come out for this sort of hearing.

But this leaves open the question about the raw theft and blatant destruction that the fine "firms" headquartered and operating in New York - right up your back yard - are and have been promulgating, and why it is that there hasn't been any serious attempt to put a stop to it - until now.

Indeed, the same BS games are still going on today. Wells Fargo and Citibank both have well over one trillion dollars off balance sheet in "God knows whats", worth God knows even less, and investors have exactly no knowledge of precisely what sort of trash is in there.

Municipal governments? Jefferson County Alabama anyone? How many more Jefferson County's are there? We know these sorts of "deals" were written literally everywhere, and that in at least one case the underlying bond issue allegedly "protected" was never made, so this deal was nothing other than a raw bet on interest rates - made by a municipal government that was goaded into it by these very same banks.

“It’s like buying fire insurance on your neighbor’s house—you create an incentive to burn down the house.”

It's only insurance Carolyn if the person who wrote the policy can pay and the buyer has an insurable interest.

If the seller can't pay because they don't have the money or the buyer doesn't have an insurable interest, it's either a garden-variety scam or an inducement to commit financial arson. When the latter is done "off exchange" where the trades are not made public and accessible then the incentives for someone to run around with a can of gasoline become nearly insurmountable.

Perhaps the fine Congresswoman can explain why is it that nobody's in jail for this yet - and why our government still allows this BS to continue.

Bernanke (and others) One-Dimensional Thinking

nospam@example.com (Karl Denninger) — Tue, 02 Mar 2010 12:31:00 -0500

Ambrose Evans-Pritchard is entirely off the deep end with this mess:

The West risks a slow grind into debt-deflation unless central banks offset fiscal tightening with monetary stimulus – QE, of course – to keep demand alive. Yet the Fed and the European Central Bank are letting credit contract.

Letting credit contract?

Of course there's the famous 2002 Bernanke Speech, also displaying an amazingly one-dimensional view of reality:

Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.

Amazing. Here's a man with a mandate to manage credit aggregates and he's talking about one of the effects of credit aggregates - price.

Yet when you read through Bernanke's so-called "seminal" helicopter paper you find even more evidence of one-dimensional thinking. For example, tidbits like this:

Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value.

The implication, of course, is that if one has inflation then the repayment of debts is "easier". But as I will explore and explain here, that premise is dangerously false.

We must first agree on a few principles which I have espoused for the entirety of the time that The Market Ticker has been in publication (and before, if you find my earlier writings.)

The first and most important of these principles is that nobody works for free. That is, no business intentionally runs at a loss, and nobody handles a financial transaction of any sort without being compensated in some form.

This is similar to the physical world and the laws of thermodynamics which, in essence, boil down to TANSTAAFL, or "There ain't no such thing as a free lunch." That is, in the physical world if you wish to convert energy from one form to another, there will be some sort of loss in the conversion, no matter what you do.

Such is an inescapable reality of the physical world, and it applies to the financial world as well. While there are certainly isolated cases in which people appear to work for free or a negative cost, when looked at in aggregate the economic world looks an awful lot like the physical world as seen through the lens of thermodynamics. To put it simply every element of economics has "slippage", or inefficiency, inherent in each and every transaction that takes place.

The general principle of slippage is what makes attempting to use inflation to "reduce debt" a pointless exercise. Let's take an example.

Let's assume that Joe has $5,000 in credit-card debt. He makes $30,000 a year.

Bernanke "decides" he is going to implement a policy of debasing the currency by 5% to try to "help" the economy by making it easier to pay debts.

What happens to Joe?

Joe's employer makes widgets. These widgets have raw materials, energy and labor as inputs and are sold on the marketplace.

When Ben implements his policy the single-dimensional view of the world is by devaluing the currency by 5% means that Joe now "makes" $31,500 a year instead of $30,000, and thus has an "extra" $1,500 to make his debt payments with.

But that sort of single-dimensional view is in fact wrong!

When Bernanke implements his policy the following things happen:

The interest rate Joe gets charged goes up, if the interest rate can adjust. The reason for this, of course, is that the person who loaned Joe the money is unwilling to accept a negative return. If he can, he will thus immediately adjust upward the demanded interest rate. We see this in floating-rate credit cards that are tied to various market rates (e.g. the Prime Rate, etc.)
Joe's employer gets a nasty surprise. Some of the raw materials that go into the widgets contain petroleum. The price of oil goes up immediately in anticipation of this policy change, and it rises by far more than 5%. Why? Because the dollar is the world's "reserve currency" and the oil exporters, as a consequence, hold a lot of dollars. The price of oil thus adjusts to both reflect the forward risk of even more devaluation and to recover the embedded market loss on the reserves the oil exporters already hold. So the price of oil goes from $35 to $80 - more than a doubling - in the space of months.
Joe's employer tries to raise prices so he can recover the increased (nominal) costs he is experiencing. But he runs into a problem - virtually everything that people have to buy contains oil, either directly or indirectly. Further, all those firms compute profit as a percentage, not as a number of dollars, just as Joe's employer does. Therefore the price of those necessities rise, and this reduces discretionary income for consumers, making very difficult a 5% increase in price for widgets. If Joe's employer cannot sustain an increase in price and also cannot operate profitably without it, Joe will be laid off (and now have zero income instead of his $31,500 mythical imputed income Bernanke believes he will obtain.)
Joe's employer, assuming he can manage to get a 5% increase in the price of his widgets to stick, has a further problem. He wants to make money. Joe therefore will get something less than a 5% raise, simply because Joe's employer must compensate for the forward risk of further devaluation and the uncertainty of his input costs. Again, the inherent inefficiency in economic decisions makes this necessary. Therefore, Joe likely only gets a $1,000 raise, not a $1,500 one. Thus, Joe "sees" only a 3% increase in his gross wages, while the general price increase predicted by the monetary inflation is 5%. Joe is now behind.
It is often said that inflation "taxes savers." The truth is that it taxes everyone because all economic decisions have a time component to them and time has a price associated with it both in direct cost and uncertainty premium. The oil-rich firm holding dollars has a "time horizon" on their reserves that is imputed into their holdings, as does the vendor who quotes steel for delivery three months from today. Due to the reality of slippage - both the uncertainty represented in time value and the inefficiency of all business activity - this causes the pass-through as "desired" and "expected" to always fall short. In short, the "inflation tax" screws everyone.
Finally, the ignobility of the government comes in. The income tax system is progressive. Joe's "raise" pushes him into a higher tax bracket, and in so doing his "raise" is further diluted. Sometimes the government indexes taxes for inflation - but not always.
To make it worse, government cooks the inflation numbers. If steak is too expensive they substitute hamburger under "hedonic adjustment" (after all, they're equal because they're both beef, right?) They count "owners equivalent rent" for housing instead of house prices, even though more than 60% of people are homeowners. In short the government intentionally and willfully understates price inflation - which it then, of course, bases things like inflation-indexing of taxes upon. This screws Joe even further (not coincidentally it really screws Joe's Grandfather, who is on Social Security!)

The "one-dimensional" economic theorists such as Bernanke believe that this 5% devaluation will "flow through" to Joe, giving him $1,500 more a year to make debt payments with.

But the seven effects above, along with many more that are not accounted for in this simplified analysis, show that one-dimensional thinking is Ivory-tower garbage!

In the real world Joe experiences a decrease in his disposable income in both nominal and real dollars. He gets creamed from all sides - his interest expenses rises immediately to compensate for the devaluation plus the risk that Bernanke will "do it again", suppliers of things he must buy (energy in all its forms) jack up their prices to compensate not only for the devaluation but also to recover their reserve currency holdings FX loss, his tax expense rises due to the progressive nature of income taxes and to top it off his employer is an imperfectly-efficient firm (as are all) and as such he only got a $1,000 raise instead of the $1,500 that the idealized one-dimensional model says should happen. Worse, the longer the view those who Joe deals with have (e.g. his health insurance company) the more uncertainty such a change introduces, and as a consequence the higher the premium that is charged for that uncertainty goes.

Joe gets squeezed and his disposable income margin - the amount of money he has every month after he makes his mandatory expenditures - is destroyed.

What if we instead allowed or forced increases in currency valuation - that is, monetary deflation. Well, that would be undesirable too, on-balance. Again, while interest rates would drop, inefficiency says that Joe would lose once again, because not only is the drop in interest rates inefficient (that is, the lender won't give him the entire 5%) but in addition the drop his employer experiences in input costs won't be efficiently transmitted to him either! Because his employer is not a perfectly-efficient business he will not contract Joe's earnings by 5%, he'll probably contract them by 10%. Joe once again gets screwed, and while the interest rate on his (variable rate) debt will come down, it will not do so to the same extent as does the deflation.

If, from this analysis, you deduce that there is no solution to excessive debt to be found in monetary policy you are correct.

Due to inefficiency in the economy it is not possible to tamper with monetary policy without introducing harm to everyone involved. The only monetary policy that does no harm is one that has zero inflation - that is, one in which the currency's value is free from tampering, and where the aggregate credit is matched as precisely as possible to the actual performance of the economy in output.

Since both measurement and execution of policy decisions are imperfect such an exact match cannot be obtained - but it should, nonetheless, be the only goal of a central bank or monetary policy body within the limits of ability.

This, incidentally, is rather close to what "Swarm USA" is trying to accomplish. I have some issues with the finer points of the plan, but the top-level view is spot-on. Specifically:

b. Create controls that tie overall money quantity to PRICE of ALL asset classes. Target ZERO price inflation and adjust quantity of money spent into existence without debt. Interest rates are set by the free market. This means no more long term inflation or deflation.

Hopefully you now understand by Ambrose-Evans is wrong, why Bernanke is wrong, why Paulson is wrong, why Geithner and Summers are wrong, and why Krugman is wrong. Why their single-dimensional views of the world are not only inaccurate they're dangerous, as they promote not economic stability and growth but rather the destruction of the economy over the intermediate and long term, presenting a false "prosperity" through serial asset bubbles that are both mathematically unsustainable and must burst, destroying value in each and every instance.

We must do better, and we can.

The ZIRP Trap

nospam@example.com (Karl Denninger) — Mon, 01 Mar 2010 12:47:00 -0500

IRA popped up this morning with an article that makes some of the points I've been harping on for a year or so now....

Even as bank securities holdings are rising in aggregate, loan portfolios and assets overall are shrinking at an accelerating pace - evidence, we believe, that deflation remains the chief threat to the global economy. As we said two weeks ago, when the Fed embraces a zero rate policy, what they are telling investors is that bonds and other rate-sensitive financial assets have no value. We've been talking about the shrinking bank balance sheet for more than 18 months and thankfully this key statistic is starting to get broad attention.

Right.

The problem with this premise is that not only does it destroy the asset base (think savings accounts, CDs, etc) that banks require to have a healthy lending environment, it also drives funds in two corrosive and destructive directions:

It encourages carry trades which are inherently destructive because the capital lent leaves the nation where it was borrowed. That is, it is put to work somewhere else, instead of in the borrowed currency.
It forces people out the risk curve and while at the same time it destroys bank capital bases it exposes the capital that wants a low-risk (or "risk free") home into risk assets where it can be destroyed.

When you look at credit quality of these "assets" (especially MBS) you see a truly frightening picture. The Fed's intentional overpayment has masked an enormous valuation:coupon disconnect; the internal credit quality in these things continue to go to hell, yet the coupon has been stable rather than rising to reflect this deterioration. That shouldn't happen in a rational market, but there is nothing rational about The Fed's interference.

Now consider the lowly retail investor who is in a money market fund with his "must not lose" money. He is earning zero, and many of these funds are at present absorbing fees. This is causing them to run at a net loss, as any attempt to post a negative interest rate to investors will result in an instantaneous run on the fund. Yet ZIRP makes it effectively impossible for these funds to return a positive yield.

Remember, without these funds there is no lending base and thus no credit growth. The perverse impact of ZIRP is that it destroys bank capital bases, as over time people will simply not sit for a zero yield - effectively or otherwise.

As I have noted for the last three years (and which IRA also notes in their paper) the only solution to a debt-overhang economic dislocation is to force the excessive and unpayable debt to default. These defaults bankrupt the institutions and borrowers that were imprudent, but in doing so they also clear the market. This also forces yields to rise to reasonable levels, restoring a yield curve that reflects duration and inflation risk, yet allows the capital base of the sound banks to be rebuilt, as they are able to attract deposits, especially time deposits, with reasonable yields on these instruments.

In other words, it attracts capital to the financial institutions - not debased currency or credit.

Only loaned (and thus borrowed) capital promotes economic growth.

The Fed's puerile thought process is that "all yield is the same", "all borrowing cost is the same", and "all credit source is the same." This is a chimera. The Fed is incapable of producing capital, even by printing. It can produce credit and it can debase existing money, diluting all existing currency, but it cannot create capital.

Capital is created only by real production in the economy. No other action creates it. Yet the loan of capital is what gives rise to the granting of credit without debasement of all existing currency.

The Fed is powerless to do this, but it can destroy the conditions necessary for capital to be lent.

ZIRP does exactly that by ruining the incentives necessary for those with actual capital to be induced to lend that capital.

The Fed should have learned this from Japan, but refused to look at the evidence under their nose. Instead, Bernanke has continued down a ruinous ivory-tower path born out of his own fertile imagination in relationship to how markets and incentives actually work, conflating the concepts of "money", "credit" and "capital."

Addressing this problem and correcting it requires admission that both Paulson and Bernanke, along with Summers and Geithner, were wrong.

In the world of Washington DC where "I screwed the pooch" are four words you will never hear a politician utter, such a sea change will require that either President Obama grow a pair of balls or that he be shackled by a massive shift in power in Washington DC - and those who come in to do so actually understand the difference.

Odds on that event were unavailable at presstime.

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.

Balance Sheet Fraud: Its Not Just For Enron

nospam@example.com (Karl Denninger) — Mon, 01 Mar 2010 11:03:23 -0500

Oh no. ENRON was small potatoes. Now we have evidence that this sort of game was played by nations, including Italy. When one cannot trust a balance sheet, one does not lend. We'll explore this and the implications for the Euro, the Pound, and the markets.

Join us at 3:30 today (Monday, 3/1) for a lively discussion of this subject and more.

See What $1.6 Trillion In Deficits Buys?

nospam@example.com (Karl Denninger) — Mon, 01 Mar 2010 08:57:00 -0500

Funny how the numbers seem to line up:

Real disposable income decreased 0.6 percent in January, in contrast to an increase of 0.2 percent in December. Real PCE increased 0.3 percent, compared with an increase of 0.1 percent.

Yeah, we're not making anything in actual income, but the government is forking up billions in things like unemployment and such.

The fun part of this, of course, is that the only thing that has held up the economy is that deficit spending. But for it, as I noted in my missive of Feb 23, we've borrowed and spent 14% of GDP over the last 18 months - or roughly 10% annualized.

The premise behind all of this is that if you can "prime the pump" it will lead to sustainable growth.

The error in the premise is that borrowing has to pick up but we never destroyed the excessive debt leverage that was in the system originally. As such there is no borrowing capacity - recall that one must have both a willing lender and a willing and able borrower.

There is no recovery. Buffett is on CNBS this morning talking about a "slow recovery" but he's being intentionally misleading - or he's gone insane. He talks a good game about "strong medicine" but in point of fact he then says that he's seen little evidence of an actual turn-up in the economy as a whole.

Well Warren, which is it? Either there's no recovery coming - the economy is simply being propped up until the government becomes unable (or unwilling) to continue to spend at double its tax inputs, or you're wrong.

Me? I go with the data, which says that not only is the government "stimulus" not working to produce sustainable output gains, it can't work because the excessive debt that led us into this mess is still there as a direct and proximate consequence of our government refusing to allow those who made bad loans to go out of business - both on the borrowing and lending side.