| We stand on the edge of the failure of all of American's retirement assets. Literally all of them. The road ahead is a rough one. Our nation faces an unprecedented economic mess of which we have only seen the beginning, but that mess is of our own making. We have "enjoyed" false prosperity for more than a decade fueled by intentionally-overinflated asset prices that represented not real wealth but rather a chimera grown from ridiculous and outrageously fraudulent actions by many throughout our credit, banking and regulatory systems. I've noted that a few people have cast questioning eyes at my triangle, and the 210 target off it. Some have claimed that I should be using a log scale on that chart. Yeah, yeah. I've heard that. Now let's look at what we've learned the last few days, weeks and months: - California appears to be functionally insolvent. As in now. How far is the state from widespread inability to pay police officers and firemen, and how long does it take before widescale riots break out when those who leach off the government teat for a living have their checks interrupted?
- It is increasingly clear that there is absolutely no way that the "big banking system" comprised of firms like Citi, Bank America, JP Morgan and Wells Fargo, along with a handful of others, can make it through this without one trillion or more in additional funds. Yes, it really is that bad.
- It is also increasingly clear that there are literally hundreds of midsize and smaller banks that are perfectly fine. They did not lever up, they did not write a bunch of crap commercial or residential construction paper that cannot be serviced and they most certainly did not drink the KoolAid of securitized synthetic garbage debt. Even in bad economic times traditional banking is a very profitable business - so long as you lend money to people who can pay you back or you have sufficient collateral so that if they default you don't lose your shirt. These sound banks have been frozen out of the "money fountain" and also out of the opportunity to be rewarded for their prudence. The Fed's policies have made it impossible for them to attract capital at any reasonable deposit or CD interest rate and yet their capital ratios are very healthy. These firms should and must stand and yell NOW. There is nothing wrong with the banking system. There is plenty wrong with a handful of big banks who engaged in outrageous and possibly even criminal conduct.
- Speaking of possible criminal conduct, it has now been revealed that Indymac was not the only bank that improperly booked funds and violated reporting standards - there were four more. The government has refused to identify them. Gee, can you think of four Thrifts that got in trouble in the last year and disappeared? It's not difficult is it? FOIA's anyone? Speaking of which, where's that new President Obama "transparency" in government?
- Ben Bernanke's neoclassical monetary theories have been proved incorrect. He has doubled base money in the last few months. Under neoclassical monetary theory this should have immediately produced inflation as the increase in base money would have spurred an increase in credit money (cash and credit are not the same thing, although they spend the same.) However, neoclassical monetary theory relies on a false premise - that the existence of additional base money causes the creation of credit - that is, the monetary tail wags the credit dog. In fact it is the other way around - credit is the dog and the tail cannot wag the dog. When worthy borrowers refuse to take out additional loans and unworthy borrowers cannot borrow additional base money has no effect, because each dollar of credit money must be matched by a dollar of debt. No new debt issue, no credit money expansion. Debt cannot expand because the carrying capacity for it in the economy has been reached, ergo absent Weimar-quantity printing of raw cash (on the order of $20 trillion dollars!) deflation cannot be halted until the bad debt is forced from the system. This excess came about because of knowingly unsustainable leverage - that is, credit-to-money ratios. Unfortunately until the total leverage in the system is reduced to sustainable levels there is nothing that can be done to halt demand destruction and economic contraction. Transferring leverage from the private sector to the government cannot change this outcome. In an economic system where most monetary exchange is in fact credit deleveraging always produces deflation which cannot be halted until leverage ratios return to sane and sustainable levels economy-wide.
- A nation's standard of living is not based on its ability to borrow in aggregate, but by its ability to produce. Therefore, we cannot borrow our way to prosperity nor can attempts to "spur lending" lead us out of recession. Rather we must produce actual goods and services - not push paper - to grow our way out. Over the last 20 years we have replaced production with false claims of "wealth creation" that are nothing more than the creation of additional credit through intentional mispricing of risk. That scam has now come to an end as the true lack of value has been exposed. All major busts in reasonably-modern time (e.g. back to TulipMania) have come from credit excess.
- Ben Bernanke and Alan Greenspan before him had the responsibility and authority to regulate the credit system, as did the OTS, OCC, SEC and Congress. ALL abdicated that responsibility; Congress in particular appears not to understand how these functions work, but the other institutions do and their abdication was willful.
- There are all sorts of theories about why prices of both stocks and bonds fell this last couple of weeks. They are all wrong. There is only one reason - supply and demand. Treasuries are being rained into the market like a monsoon and this is depressing price; what's worse is that it is sucking up money from the system which then causes a supply:demand imbalance in stocks. In order to issue the sort of supply necessary to fund the grand schemes of former Treasury Secretary Paulson, the last and present Congress and President Obama, as well as "keeping the promises made" by the previous administration (some $7 trillion worth!) the amount of supply that must be issued will literally destroy both stock and bond prices.
- We now know that not only Tim Geithner evaded taxes but in addition Tom Daschle, Obama's Health and Human Services nominee, failed to pay $100,000 in back taxes and interest. What's worse is that those taxes were incurred due to a car and driver provided Mr. Daschle by a private equity firm raising very serious conflict of interest issues. Where is my "change that we can believe in" Mr. President? I see only the very same corruption and influence peddling that Washington DC has been known for.
- There is a tremendous amount of anger rising in America. You don't see it - yet - in public, but it is there, simmering just under the surface. President Obama made note of it when it was revealed that nearly $20 billion was paid out in bonuses to Wall Street firms this year - after they took $70 billion of taxpayer money in direct assistance. That's about 30% of the total that went right out the door as bonuses. In effect, we are now paying taxes so that Wall Street can hand it out to the very people who got us into this mess!
- Government tax receipts on all levels are cratering. Income tax and sales tax numbers are frightening with many state governments reporting double-digit drops in the last month. All these handouts and bailouts sound good but where is the money going to come from? When the money runs out the game is over in truly-spectacular fashion.
- Speaking of which The Bond Market issued its statement of displeasure over the last two weeks on the idea that we'll just blow money left and right.
- Finally, that taxpayer anger and falling tax receipts, plus the government continuing to hand money to people who demonstrably not only made bad bets but engaged in outrageous and perhaps even illegal and fraudulent conduct, yet have returned nothing of what they stole sets up a very real risk of a tax revolt by Americans. It would be ruinous and nearly impossible to control if Americans decided en-masse to simply refuse to pay and to the extent possible went "off grid" through barter and underground transactions, or started modifying W4s to greatly limit withholding and then simply didn't file. Anecdotes related to this occurring are already popping up. I realize this is extremely illegal but at some point the American public is going to reach it's breaking point with the government literally stealing their money to bail out those who robbed them in the first place!
The "big bang" approach reflects the belief of Tim Geithner, Treasury secretary, and Lawrence Summers, National Economic Council director, that the Bush administration was wrong to dribble out policy initiatives. Mr Geithner intends to present a "comprehensive" plan that policymakers hope will command market confidence. Details of the financial overhaul are being finalized and have yet to be approved by President Barack Obama, but it may include both the purchase of toxic assets by a "bad bank" and insurance-style guarantees for problem assets remaining on bank balance sheets. Anti-foreclosure efforts are likely to focus on subsidizing programmes that reduce unsustainable monthly mortgage payments, though there may also be support for schemes that subsidise the partial writedown of loans that exceed the value of the home. Treasury may also unveil new efforts to revitalise dysfunctional securitisation markets. If this is all they intend to do it will fail spectacularly and the odds of a full-on market meltdown become very high because in fact this is nothing different, in reality, than what has been done thus far - and has failed. I want to expand on the bond market problem because it is absolutely critical to understand this, and for the Obama administration to put an immediate halt to it. Prices respond to only one thing in "reality" - supply and demand. Both can be illusory which produces short-term distortions but the truth always pokes its head through and when it does, the direction becomes clear. Treasury, The Fed and Congress (the previous one) have in aggregate promised some seven trillion dollars in spending they do not have. This of course will eventually require issue of debt to find it in one place or another. The current spending plans of both Treasury and Congress are guaranteed to require upwards of $2 trillion of issue this fiscal year (running through September 30th.) This last couple of weeks Treasury has been issuing bonds like crazy and as they have bond prices have taken a dive into the mud. Why? Because the supply has to be taken up by someone so that Treasury can fund the nation's promises, and as that supply is taken up money is sucked out of the system to buy those bonds. This then upsets the supply and demand picture in equities. Reality has started to intrude into the market and it's not a pretty picture. FCBs sold Treasury and so did Primary Dealers in the most recent week. This is new, it is ominous, and it signals that market participants in the bond market have detected smoke in the room. Should they all rush the door at once the bond market dislocation that I have been warning of for months will gather steam and cut off federal funding, along with kneecapping the stock market. The Fed cannot possibly absorb this supply as it will not be limited to Treasuries; they would have to print up literally $20 trillion dollars to halt the collapse and should they attempt it the dollar would collapse instead as that would be a literal ten times over expansion of the monetary base. This would produce a monetary and market implosion twice as bad as what occurred in Iceland overnight. This is where neoclassical monetary theory meets reality. In the real world credit leads, it is the dog and money supply is in fact the tail. When regulation of credit is abdicated to the degree we have seen in the last five years the resulting credit collapse cannot be avoided through diddling monetary and fiscal policy as the tail cannot wag the dog. We stand on the edge of the failure of all of American's retirement assets. Literally all of them. Buried in some of the earnings reports of the last quarter are the fact that half of the market capitalization of some firms was wiped out in the last year due to pension fund shortfalls as a consequence of the stock and credit market swoon. CALPERS and other funds are rapidly going from being adequately capitalized to critically undercapitalized. If the Treasury and Stock market both sell off as I believe both can and is likely to happen if the current policies are continued essentially ALL American Retirement Assets will be destroyed - 401ks, IRAs and both private and public Pension systems. Total losses through these systems is likely to reach 80-90%, and the Boomers start retiring "en-masse" just a few years from now. In short, if policies are not changed now there will be no retirement for Americans and the currently-retired who rely on these funds will find them gone and be forced back into the workplace. Unemployment in that scenario is likely to reach and may exceed 20%, and what's worse, Medicare funding will be severely curtailed at the same time due to the inability of the government to fund it. It is absolutely critical that Obama and Congress understand these facts (and they really are simple; we have $53 trillion in public and private debt - that is, credit - and yet the monetary base is just shy of $2 trillion up from the "normal" $800 billion or so) - it is not mathematically possible for a $2 trillion dollar thing to control the outcome of a $53 trillion thing, especially when you are threatening to add $7 trillion to it. Let me put forward a different view of what should be done, and hope that President Obama and his cabinet direct Geithner and company to take these actions. I fully realize that parts of this call for Geither to "turn on" some of his banking buddies, but irrespective of his desire not to, if he does not then the plan will fail. Specifically, we need to, here and now today: - Make at least $100 billion dollars available to existing good banks in additional capital so they can take on the good assets of banks that cannot survive in their current form with their current losses and balance-sheet garbage. (This, by the way, includes the off-balance-sheet junk that has magically "disappeared" from the public's radar, but you can be certain it IS still there.) This is essential so that the banking system, as opposed to individual banks, remains operational now and into the future. The "your ATM card doesn't work" scenario must not be allowed to occur.
- The "bad banks" that created this mess must not be further rewarded. The public simply won't stand for it. This is no longer an option and if President Obama and the rest of the government is too tone-deaf to understand this they will make a monumental mistake. Americans tolerated the first $350 billion going to these clowns because we were told that they would use it to restart lending and that it was necessary to prevent an all-on economic collapse. The money was spent on bonuses, acquisitions, and stuffed in The Fed's vault where it now earns interest, proving beyond a doubt that the original claim was a lie. If Washington thinks they'll get away with this a second time they are sadly mistaken.
- The "promises" made to backstop the failed credits represented in Freddie, Fannie, AIG and elsewhere cannot be kept. Read back through the above - if Government continues to attempt to issue Treasuries into the market they will precipitate both a bond and stock market collapse. This is a mathematical reality and the market has been issuing warnings now since the beginning of the month. January was the worst "first" month of a year for the market ever and yet the new issue from Treasury was a tiny fraction of the refunding and new issue that is currently scheduled for the next few months.
- To deal with the "bad banks" we have only two choices - we can either:
- Strip them of their good assets and sell those off to the good banks, then cut them off from all public assistance and let them fend for themselves, having protected the good assets (and deposits) by placing those with sound institutions OR
- "Cram down" their equity and debt structures and resolve their balance sheet issues in this fashion.
- ALL debts must be settled - either reaffirmed with capital adequacy and ability to pay proved up or those debts must be forced into the open and restructured or defaulted. The game of "hide the sausage" among financial institutions cannot be allowed to continue; confidence must be restored and it cannot happen until and unless everyone knows that all balance sheets fairly represent a firm's assets and liabilities. The lying has gone on for long enough that nobody trusts anyone; only FULL TRANSPARENCY resolves this problem. This includes, by the way, the garbage held by The Federal Reserve - it must be forced into the open and valued with 100% transparency today, tomorrow and every day thereafter.
- President Obama has said that he intends to try to create "4% Mortgages" to "help the housing industry." Such a move will do no such thing; the market will not permit 4% mortgage rates when the cost of long money is higher than that by any mechanism other than direct subsidy. Since housing is a $30 trillion (roughly) value proposition and roughly 40% of all homes are mortgage-free even providing one percent in subsidy would cost about $150 billion a year and the worse news is that adding this to the debt load of the government would likely drive the differential much higher. At 3% such a move would run $450 billion, or more than the entire first half of the TARP - annually! This is clearly unsustainable and President Obama must stop drinking this KoolAid. The solution to housing affordability is lower home prices, not higher ones.
- There must be a public statement and immediate follow-up action from the Obama Administration on the massive fraud and abuse of the public that has occurred over the last ten years with regards to securitization, mortgage fraud, appraisal fraud and other various ENRONesque acts by the giants of Wall Street. The public wants blood and Washington had better pay attention on this point; you have hundreds of thousands of Americans who have lost their homes and close to five million who are on the continuing unemployment rolls as a direct and proximate result of this nonsense. The government cannot contain five million angry Americans with platitudes or, for that matter, anything else. There are in fact lots of "bad actors" in this mess who at minimum profited from intentional deceit in the pricing, securitization and intentional blowing of this credit bubble, and it is unjust that they are allowed to get away with it. Everyone is entitled to a fair trial but the public must know that the investigations are in process and prosecutions will be forthcoming as is appropriate. Government must not be seen as the felon in the eyes of the people or it's authority, both moral and legal, will be lost.
- Government must not act in any fashion that may cause confidence in Treasuries to be lost. This means that the trash-taking games of Treasury and The Fed must be halted now. We may be too late to prevent this and the market has issued a clear and loud warning of the potential consequences over the last month. Should the dislocation that I have warned about over the previous year occur government's funding model would be effectively cut off, forcing an immediate termination of Social Security, Medicare, and half or more of all military spending. This in turn would cause a spiraling collapse of tax receipts which in turn would squeeze government finances even further. Government must have contingency plans in place for what it will do if 75% of its financing capability simply disappears. It both can and may happen.
- Government must be prepared to provide the basic necessities of life for at least five to ten million Americans and possibly as many as fifty million - one in six. As I have noted before this means barracks-style places to sleep, food, clothing and basic medical care. Hungry, homeless and unemployed people are dangerous.
- Government must deal with the illegal alien issue. We simply cannot have tens of millions of illegal aliens consuming public resources at a time like this in our nation - period. Americans will pick strawberries if they're unemployed; that we have illegal immigrants doing this sort of work with 5 million Americans out of work is an outrage. Again, if government does not act there is a high probability that the American people will, with disastrous consequences.
Finally, for those who think that SPX 200 and DOW 2,000 is a "pipe dream" let me point out that the DOW was at 2000 in as we turned into 1988 and the SPX was at 250. Pipe dream? Not at all. When did the insane credit creation antics begin? Shortly after the 1987 crash, that's when. Here's a long-term chart - you tell me what "mean reversion" takes us back to. Oh, and yet another basic technical analysis principle is that an "M" formation (otherwise known as a "double top") usually retraces the at least the entire run that produced the left-side of the "M". We can argue over whether that's 200 or 450 - either is really, really bad. President Obama must decide - he either stands for this nation, the Constitution (as he pledged when he took the oath of office) and its citizens or he stands for the fraud, abuse, and raw theft that has been perpetrated against us all. The markets have sent a clear signal over the last month - attempting to "borrow and spend" to prop up failed institutions and shield them from the consequences of their bad decisions, when those bad decisions exceed in aggregate the federal budget, cannot be done. If Treasury attempts to issue the amount of supply necessary to fund this it is virtually certain to cause a major meltdown in both the stock and bond markets, and this may be right around the corner as the quarterly refunding is upon us. There is no middle ground and President Obama must choose. Our new President was elected to office by the people who were tired of Washington DC influence peddling, pervasive fraud and theft and the economic damage it has wrought on this land. President Obama now has two high-level appointees he has continued to support after they were revealed to have "ethics issues" (at best.) If President Obama does not choose here and now to stand with American citizens and against the fraud and corruption of the previous twenty years he will at best be a one-term President and at worst there won't be an economy or nation worth being President of within the next year or two. The situation really is this grim and neither the markets or the people are going to sit still for any more of "business as usual." Words will not cut it - it is only deeds that count now. This is not the time for "bipartisanship" or any such thing. It is time for President Obama to demonstrate that he is the leader the people elected and to stand up for the common man - not through "paying back" organized labor with things like "card check" and ordering the removal of disclosure statements of union worker rights related to the ability to "opt out" of political activity, but rather by standing with the common man against the pervasive fraud, abuse, theft and lies that have been perpetrated by Wall Street, K Street and Washington DC in general over the previous twenty years. The road ahead is a rough one. Our nation faces an unprecedented economic mess of which we have only seen the beginning, but that mess is of our own making. We have "enjoyed" false prosperity for more than a decade fueled by intentionally-overinflated asset prices that represented not real wealth but rather a chimera grown from ridiculous and outrageously fraudulent actions by many throughout our credit, banking and regulatory systems. The blame for this cannot be laid at the feet of either political party to the exclusion of the other. Both sides of the aisle are to blame, as both have held the reins of power during this period of time. There are dozens of Senators and Representatives who have dirty hands, including many who personally profited from "special deals" doled out by some of these firms, in many cases to the tune of tens of thousands of dollars. Reported frauds have been intentionally ignored and both lawmakers and regulators have not only looked the other way but in many cases have been actively complicit. Our nation truly stands on the precipice of history. We cannot borrow and spend our way out of this mess, we cannot pass $800 billion dollar "stimulus bills" that do not actually stimulate the economy and we cannot rob Peter to pay Paul. Asset prices must contract to reasonable, supportable values, and they will - whether we like it or not. Those who are overlevered and in debt up to their eyeballs will and must default, and have that debt cleared. Transparency must not be a word, it must be a deed throughout our financial system and markets. |
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