Monday, March 16, 2009
About the Fiat Moneys...
The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which – through a complex series of steps – the bank accept in place of tangible assets and treat as if they were an actual deposit, i.e., the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.
In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government‐created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.
This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the “hidden” confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.
One of the most interesting points the paper makes is that the US is in relatively good shape, that the rest of the world is even more leveraged than the US:
The silver lining in our research is that the U.S. is one of the least levered countries in the world! Just saying that puts a bit of fear into me, but it is true. The U.S. is less levered and less exposed to radical economic deterioration than Western Europe. It is also far less dependent than East Asia on worldwide trade that is a byproduct of the net aggregate demand that previously emanated from the U.S. and other parts of the developed world. East Asia is quickly catching up to Central and Eastern Europe as the most afflicted region of the global economy.
There is also this neat tidbit:
To the best of our knowledge, there has only been 160,000 metric tons of gold EVER mined in the world. At $950 per ounce, all of the gold in the world would be worth $4.887 trillion dollars. On the other hand, we estimate that there is roughly $60 trillion of fiat money (including currencies, deposits, savings, money markets and CDs) in the world. Given the fact that world governments are caught with so much credit market leverage and losses, we believe that they will – in true Keynesian color – attempt to print their way out of this mess. If this occurs, you have to ask yourself: How many of people do you think it will take to begin to question the value of paper currency when it is being debased in an attempt to save world governments? If a small fraction of them stop believing, where will they go to preserve their wealth? My guess is the U.S. dollar and precious metals.
Read the whole thing. It's not short, but it is chock-full of good stuff!
Thursday, March 12, 2009
David Seaton, Great as Usual!
Universal health care, free university education for all, a more realistic foreign policy, freeing science from superstition... All of these Obama initiatives not only sound good, they sound wonderful, thrilling.
But somehow, at this moment, the new president and his government's lovely initiatives mostly remind me of the pediatricians and the nurses at a children's cancer ward organizing a big Christmas party... for the summer.
Aside from Santa Claus, the doctors don't know who else will still be around to decorate the tree, but at least thinking about the future goodies takes our minds off of our poor little, pale, bald heads.
For, truly, at this point it is not just "it's the economy, stupid", it is more like "it's the economy, dear Jesus".
Greenspan Still Soesn't Get It!
Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have "prevented" the housing bubble. All things considered, I personally prefer Milton Friedman's performance appraisal of the Federal Reserve. In evaluating the period of 1987 to 2005, he wrote on this page in early 2006: "There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind."
In response, Tim Iacono, from The Mess That Greenspan Made, skewers him pretty good, as Friedman died in 2006 and therefore did not live to see how "difference of kind" it actually became:
That's just pathetic when you think about it...
Even after the recent admonishment from the late Milton Friedman's long-time partner Anna Schwartz as documented in "A 92-year old finger pointed squarely at the Fed", he has the chutzpah to cite favorable words from 2006.
Tom then quotes other folks who take issue with Greenspan's feeble defense, and who stick the knife in further. I particularly like this, from Ian Shephardson, quoted in the LA Times:
"Mr. Greenspan lauded lenders’ ‘innovations.’ The number of subprime ARMs rose more than ninefold from late 2000 until the peak in mid-2007, with three-quarters of the increase coming between mid-2003 and mid-2005.
"The delinquency rate on these loans, by the way, now stands at 24.2% and it is still rising rapidly. Prime fixed-rate deliquencies are at 3.92%.
"Mr. Greenspan ought to have used the pages of the Journal to apologize to the nation. Instead, his piece will stand as a testament to his hubris, or perhaps his delusions."
As Ralph very famously said in Groundhog Day, "I think both."
Tuesday, March 10, 2009
Monday, March 9, 2009
The Kunstler Agrees!
Meanwhile, if the buzz on the blogosphere is a measure of anything -- and I think it is -- then a new consensus is forming out there about where to start doing things differently. Unfortunately after less than two months in office, President Obama finds himself awkwardly behind-the-curve on this. It begins with the understanding that a general bank rescue is hopeless and, going a step further, that the people who caused the train wreck of "innovative" securities have to be prosecuted. The public's collective voice on this is muted but growing. It has been muted by the general air of blackmail that the banks have used to enthrall policy and opinion -- the "too big to fail" idea -- in effect holding the nation's future for ransom.
[snip]
The bigger question for now is whether any of these authorities will act effectively before the public simply goes apeshit and starts burning down Greenwich, Connecticut. The dangerous shift in public mood is liable to occur with shocking swiftness, in the manner of "phase change," where one moment you see a bewildered bunch of flabby clown-citizens vacuously enraptured by "American Idol," and the next moment they are transformed into a vicious mob hoisting flaming brands to the window treatments of a hedge funder's McMansion. The moment of opportunity for avoiding that outcome is looking sickeningly slim right now.
Another thing that President Obama can set into motion anytime -- and pull himself back to the head of the curve of leadership -- is to either by executive order or by proposal to congress, shut down the credit default swap system for a period of time while procedures are drawn up to place all these dubious contracts in a "clearing" market, where the holders of them will have to come clean about what they're sitting on. The lack of this procedure is allowing zombie banks to hold the United States hostage for never-ending bail-out ransoms. None of these banks are going to survive another six months anyway, so the basic blackmail motif that the whole money system will collapse if ransoms are not paid is a bluff that has to be called sooner or later in any case. So Mr. Obama might as well get on with it.
Once these two matters are dealt with -- an earnest start-up of prosecutions and disabling the credit default swap blackmail racket -- then perhaps a stressed-out and impoverished public might be induced to not go apeshit and instead get on with the mighty task of rebuilding our nation along lines that have a plausible future.
Exactly How and Why Credit Default Swaps S*ck So Incredibly Much!
I buy a CDS (Credit Default Swap) on GE (a few weeks ago) for a couple hundred basis points ($200,000 per $10 million).
The SELLER of that CDS protects against possibly having to pay by shorting whatever he can against that short credit position. This means he buys PUTs, he shorts the common, he does whatever he needs to in order to lay off that risk. He does this because if GE goes bankrupt their stock would presumably go to zero; therefore, if he has a potential $10 million exposure on the CDS he will short $10 million face value of the common stock, or buy enough PUTs to pay him $10 million if the stock goes to zero.
The PUT writer (assuming he buys PUTs), being a market-maker, will in turn short the common to lay off the risk as well.
This hammers the stock price which then reflects into the pricing models for the CDS, driving them higher.
This cycle repeats; unfortunately credit rating models include market cap as one of their inputs, which causes a credit downgrade (eventually.)
That in turn adds more pressure.
This cycle is repeated until the company is destroyed.
Why is this not a problem with options and straight short sales?
Because with both straight short sales and PUT purchases the short side is required to post margin every night, and if the price goes the wrong way they get an immediate margin call and are required to buy that position back at a loss. That in turn puts pressure UPWARDS on share price and arrests the slide.
As such the people selling short (whether stock or listed options) do not dare short in unlimited amounts, because if they get caught on the wrong side of a squeeze they are dead.
The enforcement of risk against the people betting on a bankruptcy through regulated instruments puts a natural limit on their activity and prevents an unwarranted "death spiral".
But in the CDS world there is no mark-to-market margin supervision, because there is no central counterparty supervising exposure and demanding it.
As a consequence it is only the counterparty and the written document that can demand collateral posting and usually that is either on an infrequent schedule (monthly, quarterly, annually or on an "event") or in some cases not at all provided the writer maintains some specific credit rating criteria themselves!
Without nightly margin supervision on CDS short positions these vehicles have turned into the means to launch monstrous focused attacks on specific companies; the buyer has limited risk and virtually unlimited reward.
This is exactly like me buying fire insurance on your house, and in addition I can name the amount of insurance I want to buy, even exceeding the house's value!
How nervous will you get if I buy $10 million in "fire insurance" against your $100,000 bungalow and then start stacking up gasoline cans in my driveway?
As a direct and proximate cause of this ability to distort the market it becomes possible to create self-fulfilling prophecies almost on demand, with the people doing it profiting handsomely - at the expense of American workers and otherwise-sound companies.
What Obama Must Do Pt. 2
Simply put, you must act now. If the SPX really does have a "3" handle in the next six to seven weeks your goal of "saving or creating four million jobs" will be immaterial, as half of the S&P 500 will collapse, we will have 20 million more Americans thrown out of work, unemployment will exceed 20% and we will have a Depression worse than the 1930s. The Government does not have the borrowing capacity to backstop this event - ergo, you must insure it does not happen if you wish to avoid this catastrophe.
Simply put all of the following must happen right here, right now, today:
* The CDS casino must be closed today. The AIG revelations are an outrage - we are sending tens of billions of dollars into AIG to prop up US and foreign banks as a consequence of these swaps? This can be stopped with the stroke of a pen and must happen now. Let the ISDA and bankers scream - suspend all CDS contracts until they are on an exchange with a central counterparty and margin has been established and proved. Those for which margin can't be established or proved are void as fraudulent upon issue; the money never existed to pay them off. This charade called CDS must end.
* You must pledge to send the FBI after everyone involved in the embezzlement during the previous ten and more years, whether they be borrowers, lenders, bankers or otherwise. Liars on mortgage applications, liars in marketing these securities, liars all around - all must be prosecuted.
* We must separate investment and commercial banking services. Banking is a utility function and it must be safe. We had it right with Glass-Steagall. Make it a priority to reinstate that law and force the breakup of the monsters that have led us to this cliff. If an investment bank wants to play "hedge fund" or "proprietary trading", fine - but if they blow up they must not be allowed to sink our economy and banking system.
* The Fed must be directed to open their kimono and disclose everything they are doing, daily, including what they're taking in, from whom, how it is being valued and how it is being "haircut" or margined. Equity investments made by The Fed are clearly unlawful under The Federal Reserve Act and must be immediately disgorged. If The Fed doesn't like living within the law, then Treasury must go around them and issue Treasury Notes itself; their franchise exists at our pleasure, not the other way around.
* The ongoing charade in our housing market must end. The FHA's rate of "first payment defaults" has tripled in the last year. Safe mortgages require a significant down payment - at least 10% and more commonly 20% - which means no seller-funded down payment assistance and the end of the 3% FHA down payment. Keep the VA program for our service people but the rest must be scrapped. FHA insured mortgages are a good thing but we must drive the fraudsters out of the mortgage system and prosecute them - we're not doing it, and it is dramatically exacerbating this crisis.
* Insist that every firm that is traded on a public exchange in The United States produce a consolidated balance sheet and financials without exception - no off-balance sheet games and no BS or tricks. ALL "assets" must be disclosed along with their pricing models. Any firm that refuses is delisted immediately.
[snip]
The underlying problem is confidence Mr. President, and that is something you can fix right here, right now, today.
Lock up the fraudsters, shut down the bad mortgage lending programs, close the CDS casino until it is placed under regulation and force the firms traded in this nation to produce truthful and complete financial statements.
Pledge to reinstate Glass-Steagall.
In short, remove The Bezzle and you restore confidence, breaking the back of this downward spiral.
This is all true. It is time to stop talking about taking bold steps and actually take some bold steps.Thursday, March 5, 2009
Iceland Go Boom!
Global financial ambition turned out to have a downside. When their three brand-new global-size banks collapsed, last October, Iceland’s 300,000 citizens found that they bore some kind of responsibility for $100 billion of banking losses—which works out to roughly $330,000 for every Icelandic man, woman, and child. On top of that they had tens of billions of dollars in personal losses from their own bizarre private foreign-currency speculations, and even more from the 85 percent collapse in the Icelandic stock market. The exact dollar amount of Iceland’s financial hole was essentially unknowable, as it depended on the value of the generally stable Icelandic krona, which had also crashed and was removed from the market by the Icelandic government. But it was a lot.
Interestingly, even after reading this, I'm not sure I understand exactly what happened.
Wednesday, March 4, 2009
Tuesday, March 3, 2009
"Wealthy Idiots Meet Idiot Reporter"
I've seen a lot of dumb news reports in my life, but I'm not sure anything can quite match this one from ABC News. The premise of the report is this: Barack Obama plans to raise taxes on people who make more than $250,000, so the reporter has gone and found people who earn a little more than that sum who plan to decrease their income so that they come in underneath the magic line.
Now, the obvious objection here is that the tax code doesn't work that way. A tax increase affects the marginal dollar that a person gains. That's means only every dollar over $250,000 is taxed at a higher rate. Obama is not proposing a tax system whereby somebody who goes from $249,999 to $250,000 suddenly becomes poorer. Nobody has ever enacted a tax hike like that in the history of the United States.
That doesn't stop ABC News' intrepid reporter. This story has to be read to be believed.
Great Krugman Piece
Krugman is none too happy with the lack of focus in the Obama response to the economic crisis, and quotes other people who are none too happy as well:
On this side of the Atlantic, Tim Geithner seems committed to the view that banks should stay private even if they’re bankrupt, because — well, just because. James Kwak is driven to exasperation:
To be blunt, it sounded like the “private is better” mantra we heard from the Bush administration, and (to a slightly less extent) the Clinton administration before them. Sure, most people agree you don’t want all individual lending decisions being made by bureaucrats in Washington, but that’s just a straw man. There are valid reasons to debate whether nationalization is the best solution; in particular, if you were to take over Citigroup, even for a short period of time, would that immediately weaken Bank of America so much that you would be forced to take it over the next day? And what about JPMorgan Chase? But that’s not what Geithner said. He said “private is better.”
And so is the extremely moderate Tim Duy, over the insistence of policymakers that the “true value” of assets is higher than anything the market is actually willing to pay:
Policymakers are assuming that restoring proper functioning in credit markets - and confidence in general - is equivalent to a housing price rebound. They seem incapable of envisioning a world in which this is not the case. This tunnel vision prevents policymakers of trying to devise policy which assumes that the many of the assets in the banking system are simply “bad.” For Bernanke and Geithner, there are no bad assets. Only misunderstood assets.
And we have the spectacle of James Baker — James Baker! — attacking the Obama administration from the left, calling for temporary nationalization of zombie banks as part of the recapitalization process.
The sickening feeling of drift — the sense that policymakers are refusing to face hard facts, and are dithering while the world economy burns — just keeps getting stronger.
Et Tu James A. Baker, III?
This approach is not pretty or easy. It will cost a lot of money, with the lion’s share coming from US taxpayers, at least in the short to medium term. But the alternative – a piecemeal pumping of more public money into insolvent banks in the vague hope that things will improve down the road – could truly be historic folly.
Monday, March 2, 2009
Blast From the Past
Paul Volcker, former chairman of the Federal Reserve Board and a Republican, says we face a 75 percent chance of a financial crisis within five years. Robert Rubin, former economic chief under President Clinton, says we are confronting "a day of serious reckoning" and that "the traditional immunity of advanced countries like America to a Third World-style crisis isn't a birthright."
But perhaps Peter Peterson, former chairman of the Federal Reserve Bank in New York, chairman of The Blackstone Group and a moderate Republican, put it most succinctly. "We are not paying our own way," he says. "As a nation, we are running on empty. If the ultimate test of a moral society is the heritage it leaves to its grandchildren, I would say we are failing that test."
I did not know Volcker was so smart. Even Rubin saw storm clouds ahead. Nuts!