Americans are angry that the greed, the bad judgment and the lack of integrity of the fat cat executives who have fractured our monetary system, upset our economy and caused financial harm to everyday citizens appear to have gone unpunished. What is even worse in the minds of many is that these white collar crooks continue in their highly placed jobs, enjoying multibillion-dollar bonuses and extravagant perks. They feel justice is sadly lacking in “The Establishment” when hard working Americans are the ones being made to pay for the egregious acts of the spendthrift and the dishonest who treat us with disdain.
We headed for disaster on Wall Street several years ago when paper assets referred to as derivatives rushed into heavy use. They incorporated all the worst that could be expected of the banking culture. About five years ago, a demon derivative arose in sub prime mortgage markets, clothed in paper instruments called mortgage backed securities. These investments, sub prime CDO’s (Collateralized Debt Obligations), were basically bets on whether or not the average American homeowner with a poor credit rating could make his monthly mortgage payment on his inflated home.
For bankers and mortgage brokers, loan applicants who previously would have been considered bad risks suddenly became great clients. That’s because the higher risks they represented meant the lender could charge higher rates and fees and quickly sell off the mortgage to unsuspecting institutions. With Greenspan’s low Treasury rates, low inflation and easy credit, the banks made big yields. That is, until everything started to go wrong. Then, these miracle bets began to unwind.
These bets were bought on an enormous amount of leverage. As an example, a fat cat investor goes to a broker with one million dollars. Then based on his credit rating, he leverages this amount three times. The resulting four million dollars can be invested in a fund of funds that will in turn leverage this four million three of four times and invest them in a hedge fund. Then the hedge fund will leverage these funds another three or four times and buy derivatives like sub prime CDOs, which are often themselves leveraged nine or ten times. At the end of this long credit chain, the initial one million of equity can become a one-hundred million investment out of which ninety-nine million is debt and only one million is equity. So we get an overall leverage ration of 100 to 1. The leverage money comes largely from banks who borrowed the money from the U.S. Treasury.
A problem arises when mortgages begin defaulting and the fat cat’s credit rating is downgraded. They have to put up more money to cover the bet. In order to do so, the bank, the hedge fund, money market fund, private equity fund, etc. must sell investments. Problem for everyone is nobody wants derivative investments (like CDOs). They have to sell good investments (like stocks). And naturally when things sell, prices drop, which causes further selling ,and further downgrades and so on. That’s why stock, investments and markets that seem so removed from the sub prime mortgage meltdown are being affected by it. This dropping in the stock market hurts the little guys who were putting their money into banks and IRA’s. Instead of their savings being recirculated in the economy, they got forced into this fiasco that is ruining our monetary system. This is directly causing fear and anger in the American people.
The economy continues to slip away and confidence in the entire “establishment” gets even worse. We are experiencing deepening banking and credit crises and spinning toward what might be a global deflationary collapse as leverage unwinds itself. Derivative shake outs have a long way to go. Corporate deleveraging still has a toll to take.
What we are now seeing in Washington is a continuation of the monetary and fiscal policy followed by Alan Greenspan in attempting to change economic cycling. It is based on the Money Supply Theory which holds that massive amounts of money can enhance and increase consumer demand. Those in control of economic policy believe that more money will keep prices up (reduce deflation scare) and improve output. But if one’s eyes and ears are open, they will sense that people are angry and scared. They don’t take on more debt or run out and spend more just because money supply has been increased by the government. Many will resent being deluged with more taxpayer debt in the economy, which will only prolong the downturn.
This kind of government policy is what fed the leveraging and the derivatives that have plagued us in the first place. It reveals that government is not acknowledging the errors in policy that need urgent changing. It’s core beliefs are flawed.
People are scared of the debt and rightfully so. There are limits to what the monetary system can endure. When people are scared, they save, cut back and use their money to pay down debt. When debt is removed, economic activity will pick up. This is Economic Debt-Deflations Theory and it has been proven in reality. The Money Supply Theory has failed in past reality.
We need to get to work cleaning up the debris of spend, spend, spend policy and make a complete overhaul of Wall Street gimmickry. Abusive practices must be eliminated. Then watch the American confidence take over. The big problem is we are doing the opposite of what is needed.
Monday, March 9, 2009
Fat Cats Stacking the Deck
The ingenuity of Wall Street has been instrumental in the growth of the American economy. Now the corruption of Wall Street creations appears to be tearing down that same economy as well as the emerging world economy.
Financial leveraging within our monetary system was the springboard that facilitated economic growth. Now it is a vehicle in the hands of the fat cats it inadvertently created, who have exploited it for transfer of political power (leveraged buyouts) and to take greedy advantage in monetary system functioning (leveraged use of demon derivatives).
In a previous column, I alluded to the corruptive use of a leveraged subprime CDO (Collateralized Debt Obligation) and referred to it as a demon derivative. It was an aberration of a simple document created to facilitate the transfer of title on sales of mortgages.
The next demon derivatives of Wall Street, credit default swaps (CDS) appear to be on the verge of being released in full fury on an already staggering banking community. They are the aberration of an original simple document used to insure a bond holder against the risk of default by the originator of the bond. Now they are a potpourri of designs used to cover many risks including defaults; bankruptcies; and credit rating downgrading of corporations, banks, other financial entities and countries.
Their distinguishing features are (1) that the firm selling the CDS is not required to set aside any reserves from the premiums received to insure against possible future loss claims and (2) the buyer does not need to own an underlying security or have any other form of direct credit exposure. What was originally intended as insurance has become a bevy or highly leveraged speculative bets. You can take a bet that Citibank, General Motors and Abu Dhabi will go bankrupt.
In a typical CDS deal, as originally conceived, a hedge fund will sell protection to a bank, which will then resell the same protection to another bank and such dealing will continue, sometimes in a circle. This practice has the potential to put investors into webs of relationships which are not transparent. The failure of an insuring company can unravel the hedging use of CDSs and lead to increasing risks of bankruptcy. The fear of this eventuality after the demise of Lehman Bros. (investment bank) and AIG (insurance company) was a contributing factor in the massive decrease in lending liquidity in the fall of 2008. Fear of the potential for loss of insurance actually froze the credit market and the cycling of funds in the monetary system. This injection of fear had a debilitating effect on the functioning of the financial system.
But we haven’t seen anything yet. Using leveraged (taxpayer) money to bet on the survival of large companies, banks and even sovereign countries is wildly reckless. We will soon find out why, the hard way. Purely speculative use of CDSs should be outlawed without delay. Those using leverage to finance such betting have put a potential multitrillion dollar noose around the neck of our economy. The magnitude of the exposure is hard to predict because the extent of offsetting hedging, if any, is unknown. The noose could be removed by the simple act of outlawing purely speculative derivative gambling retroactively and removing all outstanding bets effective immediately.
In the past seven years trading in the CDS market has leapt a mind boggling hundred fold. The Depository Trust and Clearing Corp. which runs a warehouse of trade confirmations for CDS (about 90% of the market) held $29.2 trillion of outstanding trades as of December 26, 2008. The market growth is largely attributed to investors wishing to bet for or against the likelihood that particular companies or portfolios would suffer financial difficulties, rather than those that insure against bad debt.
Since these bets are all based on the future creditworthiness of a country, company or consumer (basically a bet on the ability of a party to repay his debts) they’re all about to go horribly wrong.
In a global economy made up of thousands of corporations and institutions, many of which borrowed 10-100 times their capital in the past few years, most will be unable to repay their future debts. This means these new demon derivatives are going to unwind rapidly with fall out potentially much larger than that caused by the credit crisis so far…unless Congress acts swiftly.
Our economy can recover quickly when Americans work through the malaise with confidence. We need to scream loudly in protest of the spending and insist upon the complete removal of gambling from our financial system. Economic recovery spending is digging the hole of taxpayer debt and gambling is wrecking the stability of our monetary system.
But Congress is (1) too busy spending and creating debt to be piled on taxpayers backs; (2) oblivious of the present and impending damage to our monetary system emanating from the infiltration of pure gambling and (3) will allow the derivative leveraging to be absorbed in impending losses to be borne by the economy or by future bailout money. Either way, the enrichment of fat cats using leverage (taxpayer money) will be completed. Remove the betting and fat cats don’t win their bets. Rather, they will participate in absorbing the losses that will otherwise be inflected on the rest of us.
Another way to explain this, is that the losers of these bets will be banks who have already gotten bailout money and government loans (taxpayer debt) that will complete the absorption of the leverage. The irony of this is that these loans and bailouts would enrich fat cats instead of being used as economic stimulants.
The government is so absorbed in the false notion that spend, spend, spend is the only policy to follow that they are only applying band aids and not diagnosing the illness. Growing cancers need to be removed. Fat cats are gambling with your money where you can only be a loser, never a winner.
Financial leveraging within our monetary system was the springboard that facilitated economic growth. Now it is a vehicle in the hands of the fat cats it inadvertently created, who have exploited it for transfer of political power (leveraged buyouts) and to take greedy advantage in monetary system functioning (leveraged use of demon derivatives).
In a previous column, I alluded to the corruptive use of a leveraged subprime CDO (Collateralized Debt Obligation) and referred to it as a demon derivative. It was an aberration of a simple document created to facilitate the transfer of title on sales of mortgages.
The next demon derivatives of Wall Street, credit default swaps (CDS) appear to be on the verge of being released in full fury on an already staggering banking community. They are the aberration of an original simple document used to insure a bond holder against the risk of default by the originator of the bond. Now they are a potpourri of designs used to cover many risks including defaults; bankruptcies; and credit rating downgrading of corporations, banks, other financial entities and countries.
Their distinguishing features are (1) that the firm selling the CDS is not required to set aside any reserves from the premiums received to insure against possible future loss claims and (2) the buyer does not need to own an underlying security or have any other form of direct credit exposure. What was originally intended as insurance has become a bevy or highly leveraged speculative bets. You can take a bet that Citibank, General Motors and Abu Dhabi will go bankrupt.
In a typical CDS deal, as originally conceived, a hedge fund will sell protection to a bank, which will then resell the same protection to another bank and such dealing will continue, sometimes in a circle. This practice has the potential to put investors into webs of relationships which are not transparent. The failure of an insuring company can unravel the hedging use of CDSs and lead to increasing risks of bankruptcy. The fear of this eventuality after the demise of Lehman Bros. (investment bank) and AIG (insurance company) was a contributing factor in the massive decrease in lending liquidity in the fall of 2008. Fear of the potential for loss of insurance actually froze the credit market and the cycling of funds in the monetary system. This injection of fear had a debilitating effect on the functioning of the financial system.
But we haven’t seen anything yet. Using leveraged (taxpayer) money to bet on the survival of large companies, banks and even sovereign countries is wildly reckless. We will soon find out why, the hard way. Purely speculative use of CDSs should be outlawed without delay. Those using leverage to finance such betting have put a potential multitrillion dollar noose around the neck of our economy. The magnitude of the exposure is hard to predict because the extent of offsetting hedging, if any, is unknown. The noose could be removed by the simple act of outlawing purely speculative derivative gambling retroactively and removing all outstanding bets effective immediately.
In the past seven years trading in the CDS market has leapt a mind boggling hundred fold. The Depository Trust and Clearing Corp. which runs a warehouse of trade confirmations for CDS (about 90% of the market) held $29.2 trillion of outstanding trades as of December 26, 2008. The market growth is largely attributed to investors wishing to bet for or against the likelihood that particular companies or portfolios would suffer financial difficulties, rather than those that insure against bad debt.
Since these bets are all based on the future creditworthiness of a country, company or consumer (basically a bet on the ability of a party to repay his debts) they’re all about to go horribly wrong.
In a global economy made up of thousands of corporations and institutions, many of which borrowed 10-100 times their capital in the past few years, most will be unable to repay their future debts. This means these new demon derivatives are going to unwind rapidly with fall out potentially much larger than that caused by the credit crisis so far…unless Congress acts swiftly.
Our economy can recover quickly when Americans work through the malaise with confidence. We need to scream loudly in protest of the spending and insist upon the complete removal of gambling from our financial system. Economic recovery spending is digging the hole of taxpayer debt and gambling is wrecking the stability of our monetary system.
But Congress is (1) too busy spending and creating debt to be piled on taxpayers backs; (2) oblivious of the present and impending damage to our monetary system emanating from the infiltration of pure gambling and (3) will allow the derivative leveraging to be absorbed in impending losses to be borne by the economy or by future bailout money. Either way, the enrichment of fat cats using leverage (taxpayer money) will be completed. Remove the betting and fat cats don’t win their bets. Rather, they will participate in absorbing the losses that will otherwise be inflected on the rest of us.
Another way to explain this, is that the losers of these bets will be banks who have already gotten bailout money and government loans (taxpayer debt) that will complete the absorption of the leverage. The irony of this is that these loans and bailouts would enrich fat cats instead of being used as economic stimulants.
The government is so absorbed in the false notion that spend, spend, spend is the only policy to follow that they are only applying band aids and not diagnosing the illness. Growing cancers need to be removed. Fat cats are gambling with your money where you can only be a loser, never a winner.
It's Time to let America know what's really going on
Most of our policy makers lack a clue at what is really going on and what is really at stake when dealing with (1) our monetary system and (2) economic matters. While these two are inexorably entwined, there is a disconnect. The monetary system involves tangible script and more static truths while the economy is more reactive to cyclical change and psychological influences.
In the former, the functioning of the system depends on savings, application of savings to economic replenishment and, wise consumption. These functions are mandatory not optional. Quantifiable boundaries, although fluctuating with economic growth and contraction are breachable with economic collapse an eventual result.
In the latter, psychological factors play a large role in economic cycle beginnings, fluctuations and endings. Such factors must be recognized when monitoring economic realities and considered when courses of action are contemplated.
The Enron fiasco planted the seed of distrust of Wall Street and the government in the minds of investors after it was determined that a tactic referred to as off balance sheet financing was used to hide debt and rip off investors. This same tactic has now been clothed in paper instruments called asset backed or mortgage backed securities. It has been used by banks to hide debt that prevented regulators from detecting violations of rules setting leverage limitations on banks. These paper instruments proliferated when the Feds implemented their ill conceived policy of attempting to alter economic cycles by tinkering with interest rates.
The securities included simple loans bundled together, then sliced and diced up into a big beautiful salad. The idea was to sell individual servings of financial salad around the world. The securities were insured by more dubious paper instruments called credit default swaps. These swaps were more in the nature of gambling bets than insurance as normal underwriting procedures were not involved in their creation. Of course, all were offered for huge fees. Wary of such creations, global investors declared a buyers strike against these paper instruments. They left the salad for we Americans.
Alan Greenspan created a feeding frenzy on the salad when he began lowering treasury bond rates to historic lows tinkering with the economy. He drove safe investment money into the salad.
Anxieties were created among American investors when the toxic waste of housing foreclosures appeared in the salad. Eat some and you are dead. Americans began realizing that the salad was being served while the Chairman of Fannie Mae was liberalizing lending policies and leveraging assets at 100 to1 to the detriment of the taxpayer, a reckless, inconceivable reality.
The American psyche has been fractured by this gimmickry along with our monetary system. The public has lost all confidence in the government and Wall Street. The economy is tanking.
The Feds and Wall Street then place a veil of secrecy over the use of bailout money. They are hiding the devastating carnage of leveraged buyout corruption. The odor is revealing.
Now our policy makers must face a real dilemma. They must stimulate the fading economy without cratering the monetary system. Without a clue, they are panicking toward out of control spending, the path to collapse of the monetary system. We must seek ways to repair the American psyche. More thoughtful planning must be openly revealed. Obama is pushing for better regulation of Wall Street. We need to crack down with tough new laws now.
Our policy leaders in Washington are thinking domestically only, when our credit crisis is global. It is not that the world lacks money; it is that the world’s money is sitting on the sidelines. The first challenge is to reform our financial system quickly. The first step should be to make any future for asset-backed paper more transparent and credible or return to simpler forms of asset pass throughs. We need the U. S. dollars consumed in the purchasing of foreign goods to be returned as replenishments in our monetary system. This need must be facilitated, not discouraged.
Much more needs to be cleaned up in the way American business, in general and Wall Street in particular, operates. Most Americans feel that businesses flagrantly make things more complicated in order to hide real risks. How can trust be rebuilt amid today’s deceptive propositions, double talk, disclaimers and lack of consumer protection? Business needs to do more than improve governance and raise capital. They need to incorporate clarity and simplicity into their programs and communications. They need to come out from behind unintelligible language. They must discontinue leading blind politicians into self serving actions that disadvantage consumers.
Government has abdicated its responsibilities to the American people. It is devoid of leadership; handicapped by political ideology; and political hubris; and plagued by incompetency. Individual Americans must step up to the plate with some clout.
Obama needs to seek exclusive consensus of the most knowledgeable economists who understand the functioning of the monetary system. He must explain the causes, I have alluded to. He must explain how the path chosen will avoid monetary system collapse and how it will provide jobs. He must let natural bankruptcy clear out the garbage.
In the former, the functioning of the system depends on savings, application of savings to economic replenishment and, wise consumption. These functions are mandatory not optional. Quantifiable boundaries, although fluctuating with economic growth and contraction are breachable with economic collapse an eventual result.
In the latter, psychological factors play a large role in economic cycle beginnings, fluctuations and endings. Such factors must be recognized when monitoring economic realities and considered when courses of action are contemplated.
The Enron fiasco planted the seed of distrust of Wall Street and the government in the minds of investors after it was determined that a tactic referred to as off balance sheet financing was used to hide debt and rip off investors. This same tactic has now been clothed in paper instruments called asset backed or mortgage backed securities. It has been used by banks to hide debt that prevented regulators from detecting violations of rules setting leverage limitations on banks. These paper instruments proliferated when the Feds implemented their ill conceived policy of attempting to alter economic cycles by tinkering with interest rates.
The securities included simple loans bundled together, then sliced and diced up into a big beautiful salad. The idea was to sell individual servings of financial salad around the world. The securities were insured by more dubious paper instruments called credit default swaps. These swaps were more in the nature of gambling bets than insurance as normal underwriting procedures were not involved in their creation. Of course, all were offered for huge fees. Wary of such creations, global investors declared a buyers strike against these paper instruments. They left the salad for we Americans.
Alan Greenspan created a feeding frenzy on the salad when he began lowering treasury bond rates to historic lows tinkering with the economy. He drove safe investment money into the salad.
Anxieties were created among American investors when the toxic waste of housing foreclosures appeared in the salad. Eat some and you are dead. Americans began realizing that the salad was being served while the Chairman of Fannie Mae was liberalizing lending policies and leveraging assets at 100 to1 to the detriment of the taxpayer, a reckless, inconceivable reality.
The American psyche has been fractured by this gimmickry along with our monetary system. The public has lost all confidence in the government and Wall Street. The economy is tanking.
The Feds and Wall Street then place a veil of secrecy over the use of bailout money. They are hiding the devastating carnage of leveraged buyout corruption. The odor is revealing.
Now our policy makers must face a real dilemma. They must stimulate the fading economy without cratering the monetary system. Without a clue, they are panicking toward out of control spending, the path to collapse of the monetary system. We must seek ways to repair the American psyche. More thoughtful planning must be openly revealed. Obama is pushing for better regulation of Wall Street. We need to crack down with tough new laws now.
Our policy leaders in Washington are thinking domestically only, when our credit crisis is global. It is not that the world lacks money; it is that the world’s money is sitting on the sidelines. The first challenge is to reform our financial system quickly. The first step should be to make any future for asset-backed paper more transparent and credible or return to simpler forms of asset pass throughs. We need the U. S. dollars consumed in the purchasing of foreign goods to be returned as replenishments in our monetary system. This need must be facilitated, not discouraged.
Much more needs to be cleaned up in the way American business, in general and Wall Street in particular, operates. Most Americans feel that businesses flagrantly make things more complicated in order to hide real risks. How can trust be rebuilt amid today’s deceptive propositions, double talk, disclaimers and lack of consumer protection? Business needs to do more than improve governance and raise capital. They need to incorporate clarity and simplicity into their programs and communications. They need to come out from behind unintelligible language. They must discontinue leading blind politicians into self serving actions that disadvantage consumers.
Government has abdicated its responsibilities to the American people. It is devoid of leadership; handicapped by political ideology; and political hubris; and plagued by incompetency. Individual Americans must step up to the plate with some clout.
Obama needs to seek exclusive consensus of the most knowledgeable economists who understand the functioning of the monetary system. He must explain the causes, I have alluded to. He must explain how the path chosen will avoid monetary system collapse and how it will provide jobs. He must let natural bankruptcy clear out the garbage.
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