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A Sober Warning To The GOP - And The Democrats

nospam@example.com (Karl Denninger) — Wed, 21 Apr 2010 08:32:03 -0400

The political witch-hunt that is now being fomented related to the SEC's charges against Goldman is a minefield that threatens to blow up the GOP for the next 20 years - if not permanently.

The full-court press by right-wing talking heads such as Limbaugh and Hannity, who appear to have not bothered to do a bit of research into the matter before spouting off absolute nonsense, are piling on in a fashion that will just do further damage to the Republican brand.

The premise here is that the SEC action was "concocted" in some fashion. Well, if that's true, how come the key trader involved, Tourre, has been de-registered in London?

Fabrice Tourre – the bond trader at the heart of Goldman Sachs' fraud case – was on Tuesday barred from working in the City of London in the first 'victory' for financial regulators on both sides of the Atlantic.

That's not what you do if you did nothing wrong - or your employee did nothing wrong, conference call by Goldman with many "ahs" and "uhms" notwithstanding.

It may get much worse. Zerohedge is reporting that the infamous C-BASS, the company formed by MGIC and Radian (and over which their pending merger blew itself to bits a couple of years ago), may be intertwined in the Goldman mess. There may be a story here - or maybe not. We'll see as time passes.

In the meantime there are a few Democrats that are not waiting around. Marcy Kaptur (D-OH), among others, sent a letter to Eric Holder, US Attorney General, in which she said:

If both global and domestic confidence in the integrity of the U.S. financial system is to be regained, there must be confidence that criminal acts will be vigorously pursued and perpetrators punished.

While the SEC lacks the authority to act beyond civil actions, the U.S. Department of Justice (DOJ) has the power to file criminal actions against those who commit financial fraud. We ask assurance from you that the U.S. Department of Justice is closely looking at this case and similar cases to further investigate and prosecute the criminals involved in this, and other financially fraudulent acts. .....

Exactly.

So precisely what are the Republicans trying to argue for here? That the sort of misconduct that is alleged to have occurred here beyond the boundaries of the law, and that which does not rise to a criminal standard of conduct but which is exploitive of Americans, should be permitted to slide - either "because it's in the past" or for more sinister reasons - like permitting the same looting to continue and be expanded in the future?

Don't feed me this crap about "expanding credit for Americans" - we've done that and it was a freaking DISASTER! Liar loans, 0 down, totally irresponsible HELOC and other lending policies, people tying small businesses to their houses and personal fortunes all so the bankers could skim off a huge piece of everything - and it all blew up.

Now "they're back" and making billions in bonuses - but what are they doing to earn that money? Banking and finance generally is a parasitic function. It's a necessary function, but only to a point. Yes, we need to match those with capital with those who want to borrow capital, and that's what banks do - but we don't need to feed an insatiable monster that "demands" products that are unsound, unsafe, and crooked at their inception, nor do we have to permit these same bankers to continue to lie about their asset valuations.

Yet we are.

Let me be clear: The system will not hold together on the path we are on now. It can't. It is demanding to be fed with ever-greater interest payments and ever-larger slices of the economy siphoned off, and the real economy can't withstand that sort of attack.

Look at consumer confidence - it came in at -50 today, just off record lows, .vs. projections of "improvement." Improvement? Where? The real economy is choking to death under 29.9% interest rates as the bankster monster sits on it and plays vampire, sucking the blood from the economy.

And Mayor Bloomberg has the chutzpa to tell the NYC Congressional delegation that they have to "fight" for NY. Fight? For what? For the ability to steal even more?

Jefferson County Alabama funded NY's fat-cat bankers and taxes - with a bribery scheme that sent several officials to prison. WHERE ARE THE INDICTMENTS OF THE BANKERS INVOLVED? The banks involved included in the swap deals that were both overpriced and may have been entered into in exchange for bribes include JP Morgan, Bear Stearns, Bank of America and Lehman Brothers. Two of the four are now dead, of course, but the other two are not.

Oh, Mr. Langford? He got 15 years. How many years have the bankers gotten?

NOT ONE DAMN DAY.

Oh, Bill Blount (who did the bribing) went to prison too - he pled guilty.

The bankers - and the banks themselves - that profited from this crooked set of deals? Not one penny has come back to the citizens of Birmingham, Alabama, nor has one bank executive been indicted. Never mind that Matt Taibbi has alleged that Goldman was effectively bribed to the tune of $3 million to stay out of the deals - by JP Morgan!

Oh, and before anyone tries to hide behind a claim that "they didn't know", you might want to read this:

Here you can see a trail that leads directly from a billion-dollar predatory swap deal cooked up at the highest levels of America's biggest banks, across a vast fruited plain of bribes and felonies — "the price of doing business," as one JP Morgan banker says on tape — all the way down to Lisa Pack's sewer bill and the mass layoffs in Birmingham.

Didn't know eh? That dog won't hunt.

We can't stop it? Like hell. Bill Black did stop it. Listen up:

The banksters threatened to kill him by the way. Literally.

To Congress and President Obama: Stop lying. You can put a stop to the scams - you're refusing. You're not unable, you're unwilling. But this position you've adopted - the making of excuses and continued sponsorship of the scams and frauds of these "bastions of banking" has us moving ever-closer to the cliff, and once we go off it, there is no coming back.

Let me make this clear. I'm a man of peaceful protest and I've called for legal and legislative remedies. 100 years of hard time with Bubba in the slammer for these clowns will do just fine. In fact I prefer it to violence, in that hard felony prison time will both last longer and hurt more.

But I'm not the only one out here, and a lot of the people in this country are tired of the crap and within a hair of deciding that it's time to roll up judge and jury into one, passing sentence personally. Howard Fineman, writing for Newsweek, sees the problem but as with most "pundits" refuse to identify the culprit, as pissing off half your advertisers (every big bank in the land) can impact tenure with the publication you write for.

The people are done with being robbed, looted, bent over the table and violated repeatedly, while our nation's corporations - banks included - are fined with wrist-slaps instead of hard time or worse, their actions are IGNORED and they're even bailed out! Witness Pfizer, who I've written about - in 2009 the firm pled guilty to a criminal felony and paid $2.3 billion as a fine. What did the various agencies say at the time?

“Today’s landmark settlement is an example of the Department of Justice’s ongoing and intensive efforts to protect the American public and recover funds for the federal treasury and the public from those who seek to earn a profit through fraud. It shows one of the many ways in which federal government, in partnership with its state and local allies, can help the American people at a time when budgets are tight and health care costs are increasing,” said Associate Attorney General Tom Perrelli. “This settlement is a testament to the type of broad, coordinated effort among federal agencies and with our state and local partners that is at the core of the Department of Justice’s approach to law enforcement.”

What did Pfizer do?

American pharmaceutical giant Pfizer Inc. and its subsidiary, Pharmacia & Upjohn Company Inc., have agreed to pay $2.3 billion, the largest health care fraud settlement in the history of the Department of Justice, to resolve criminal and civil liability arising from the illegal promotion of certain pharmaceutical products, the Justice Department announced today.

This was a first offense, right? The company did a bad thing, got caught, and had been a good corporate citizen. It was an "isolated incident", yes?

Uh, no, it was not.

A division of Pfizer Inc., the world's largest drugmaker, has agreed to plead guilty to two felonies and pay $430 million in penalties to settle charges that it fraudulently promoted the drug Neurontin for a string of unapproved uses.

In an agreement announced by government prosecutors Thursday, Pfizer unit Warner-Lambert admitted that it aggressively marketed the epilepsy drug by illicit means for unrelated conditions including bipolar disorder, pain, migraine headaches, and drug and alcohol withdrawal.

Same offense, five years previous - in 2004.

There wasn't anyone involved in both of these illegal acts, right? Different people that just happened to be in the same company?

Wrong again.

Jeff Kindler, who became Pfizer’s general counsel in 2002, supervised the lawyers who made the promises to prosecutors. By 2004, Kindler increased the compliance budget 12-fold. He became chief executive officer in 2006. In Pfizer’s ethics guide, he says stories about misbehaving companies and executives abound.

“Pfizer truly stands apart,” he says. “I am proud of our record.” On Oct. 1, Kindler was elected to the board of the Federal Reserve Bank of New York. Kindler declined to comment.

Not only was the same guy the general counsel in 2002 when the first offense happened he had been promoted to CEO when the second occurred.

Mr. Kindler's "penalty" for being involved in not only one but two felony criminal violations of the law at Pfizer? He was elected (by the banks, of course) to the board of The Federal Reserve Bank of New York. Oh, and he's "proud" of Pfizer's record - a record he was responsible for.

Perhaps you can explain why the people should sit still while our government, which is supposed to enforce laws, allows not just one offense but corporate recidivism - with an offense that includes aggresisvely peddling drugs for unapproved uses. Out here in the real world we call that "drug dealing" and when the drug is heroin or PCP, and we catch them, we lock people involved up for life.

But when you run a big pharmaceutical company and in essence commit the same offense you get your hand slapped, get promoted for the first offense and then when you do it again you get elected to the board of the institution that executes monetary policy for the entire United States!

I keep brining up the Pfizer case - and the Jefferson County one - because they are outrageous in their impact on ordinary people and the brazen nature of what occurred. There's also no doubt that criminal acts were involved, since in both cases the parties (or corporations) either were found or pled guilty.

That is, these felony aren't allegations, they're facts.

But in each case the prime actors go free. Nobody does hard time and nobody even loses a business license. Pfizer wasn't shut down nor did it lose the ability to do business with the government. The banks involved in the Jefferson County Alabama swap deals were not prosecuted, they didn't lose their banking licenses, they didn't have to return any of the money they "made", and the people of the county still got screwed. Then those very same banks jacked up half the nation's credit card interest rates to 29.9% - while The Fed lent them our money at zero.

The latter is important, by the way. If I steal a car and then sell it to you, when you're caught with the stolen car you don't get to keep it. It doesn't matter if you're out lots of money as a consequence - you never had a right to the car in the first place, as it was the fruit of a poison tree. Why haven't these banks been forced to disgorge every penny that Jefferson County paid them, since the funds they got were likewise the fruit of a felonious series of events?

Oh yeah, there was allegedly a probe on the Jefferson County (and other municipalities that got scammed too) matter - in 2008.

Before the election.

WHAT CAME OF IT AND WHY HAVE THERE BEEN ZERO INDICTMENTS?

Nearly two years later, all we know is that there "was" an investigation... but we also know why the banks got involved in these slimy deals. Read it right here:

``Swap deals were more numerous and higher fees available,'' Snell said in the interview. ``In addition, swap transactions have much more flexibility for payment because there is no requirement, as there is in new money transactions, that the fees be disclosed.''

Hide the cost, hide the fees, don't disclose any of it, and, in the case of Jefferson County, if some of the officials there get involved in a little bribery, well, it's nothing that a higher fee won't take care of covering!

Or shall we talk about book-cooking? Oh hell, why not, let's do Wells Fargo, which has a grand-pappy popping $1.76 trillion freaking dollars in QSPEs off balance sheet! The alleged "maximum exposure to loss" (according to them)? A mere $43.5 billion - that is, the claim is made that a minuscule 2.4% could possibly - in the worst case - be lost, but not one penny more!

Oh, what's in the black box? Well, we can start with a cool $1.1 trillion in "conforming" mortgages, including Ginnie-guaranteed paper. The latter, by the way, has an actual guarantee from the Federal Government - but note that the breakdown between the two is not specified. Why not, given that Fannie and Freddie paper is not legally guaranteed - even though it is currently "backstopped." Given how little Ginnie did in originations prior to the FHA ramping up in the last couple of years why do I suspect that "conforming" might not even actually mean "wrapped by Fannie or Freddie"? After all, the legal term of art "conforming" in this case merely means it qualified to be sold to the GSEs - not that it was, or that it was wrapped by them!

Then there's $251 billion in non-conforming mortgages. How many of those are Wachoiva "Pick-a-Pay" monstrosities that Wells swallowed? Hmmmm... Oh, and let's add in $345 billion in commercial mortgage securitizations (not whole loans - securitizations!) which, if you remember, FITCH said 10% of the total outstanding would be in default by the end of the year.

If that's not enough for you the unconsolidated VIEs are also in the mix off balance sheet, and in there we find $56 billion in CDOs (heh, how are those performing, and what sort of CDOs are these? Are there any synthetics in there?) and, of course, just to round things out, a cool $23.8 billion in CLOs (collateralized loan obligations.)

To put this all in perspective for the company to hold the "standard" 4 and 8% Tier Capital against this the bank would have to have almost $160 billion in Tier Capital (for the 8% standard) in addition to coverage for the formal, on-balance sheet debt that the company has - and this assumes that all those "carrying values" accurately reflect the actual value of these securities. Anyone care to bet on what the market price is on this box-chock-full-of-god-knows-what should they want to - or have to - sell it?

Of course Wells doesn't have the capital behind that nor can we see what's actually in the box, other than their "category list." The "off balance sheet" games permit this sort of thing - a dandy arrangement right up until the belief that the maximum value at risk of $43 billion turns out to be a wild-eyed fantasy.

Then the taxpayer gets tapped on the shoulder and told that tanks will roll unless we fork up $700 billion tomorrow - again.

We learned exactly nothing from ENRON and MCI, or for that matter from Lehman and the 2008 debacle - did we?

Why did I pick on Wells? Besides the fact that they make it reasonably easy to find this crap in their financial statements, for no particular reason. The other banks aren't quite as bad, but when we're in the hundreds of billions off-balance sheet - does it matter?

No.

We desperately need politicians who will cut the crap and put a stop to all of this, right here and now. No more flim-flamming, no more off-balance-sheet crap, no more hidden fees, no more bribery and no more extortion. Do any of the above, go to prison - period.

If you need someone with experience in the matter, call Bill Black.

Will this "constrain credit"? Not among those who are truly qualified to borrow. Note that our local community banks didn't pull any of this garbage - bribing people, holding a trillion in so-called "assets" off balance sheet and running complex derivative books intended to make price discovery and fair dealing impossible.

Force the big banks to stop all of it right here and now. If they can't survive with everything they hold consolidated on their balance sheet, that's too bad. We have thousands of community banks that would be happy to have the business, and that will make sound loans.

Demand that The Fed cut the "below zero" real interest rates. Get rid of the Clinton-era machinations in the CPI, and mandate that the short end of the rate curve be held above the true rate of inflation. Why? Because it must always cost something to borrow in real terms or you get monstrous malinvestment, bubbles and crashes. If Bernanke won't put a stop to this garbage right here and now then The Fed's charter must be revoked.

Why aren't you doing this? Because you're being bribed, that's why:

Democrats and Republicans have held at least three dozen fund-raising events with Wall Street bankers and lobbyists for companies such as Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Morgan Stanley.

Invitations to some of the fund-raisers highlight access to lawmakers. "This unique program provides benefits designed to give you quality time with Republican policy makers through small gatherings," wrote Sen. John Cornyn (R., Texas) to Wall Street executives in an invitation to join a business council of the National Republican Senatorial Committee, which he heads.

The donation requested: $10,000. The group held discussions with GOP senators in February and March.

Democrats raising money from the financial-services industry include Senate Majority Leader Harry Reid of Nevada, who went to New York this year for a fund-raising event with several executives from Goldman Sachs.

Maybe Congress can explain why the 535 criminals in the District of Corruption shouldn't all be in prison?

Time to choose 'Dems - and 'Pubs. No more obfuscation and no more lies. You're either going to act on the fraud, or you're not. November is coming and before you think you'll skate on this one, I suggest you harken back to 2008, when everyone thought the same thing after Bear Stearns blew up.

How did that work out, exactly, and why do you think you can stop the next collapse when it comes?

If you don't act, and soon, it most certainly will.

A Sobering View Of Macro Economic Reality

nospam@example.com (Karl Denninger) — Sun, 04 Apr 2010 14:12:51 -0400

In 2001, we had a recession, right?

We recovered, right?

Are you sure?

Are you curious as to why manufacturing has continued to shift to China, why the only "good jobs" in this country seemed to be centered on ripping someone off in some way (e.g. subprime or "liar loan" mortgage brokers, stock brokers, guys selling bogus CDS against money they didn't have, etc) and why employment never really recovered - with the employment rate of the population failing to move materially higher after the 2000 recession, you might want to read the rest of this missive.

And by the way, the employment trend of the previous month? Revisions made that worse - here's the previous month's graph:

If you remember last month I said that changes in this data were "encouraging." This month however the revisions caused some negative impact on the previous month's data; this is what that same chart looks like now:

Oops. That's still below zero, isn't it? So despite all the cheerleading in the media about the positive report in point of fact we are, on balance, below where we were last month as that big positive spike got revised away!

Now let's not be too negative - the situation has improved - from the bottom. For example, the "not in labor force" chart now looks like this:

But last month it looked like this:

You wouldn't know this from the orgasmic response on CNBS Friday. But the data is what it is, and despite actual improvement this last month the improvement in the situation last month not only revised away all the improvement from this month, it revised away even more!

Leave it to government to report a number that's "good", then is revised away the next month beyond the improvement in the next month in the series, meaning that in point of fact you've moved backward, not forward.

But that's not the reason for this missive. Oh no. This Ticker is dedicated to exposing what we did in the 2000-2009 decade at a macro economic level, and why those who are calling "end of recession" need to go drink a bottle of arsenic-laced gin before they wind up really hurting people making real decisions in the economy - that is, you, I, and every business person in America.

If you remember in 2001 we had a recession. I put forward the following (rather confusing) base graph of federal debt expressed as month-over-month change, going way back to the 1990s. Click for a big copy, and have a big monitor:

The reason I'm going to confuse you with the above is that I am shortly to bring light to this matter. That is, I'm going to reduce this raw squiggle to something understandable - that is, the annual rate of change of federal debt (all-in, including on-sheet transfer payments) since the early 1990s.

Notice something: Federal debt additions through the 1990s actually shrunk - that is, the "rate of change" was negative. But look what happened when we went into the recession in 2001 - The Federal Government began spending a lot more money (on balance sheet) and despite the putative recovery beginning in 2002 they never stopped doing so. That is, the "Keynesian" stimulus that is allegedly necessary to lift the economy from recession was never retracted from the economy. And, as you can see, in the last two years this "stimulus" has gone nearly-vertical.

How much of the economy did this amount to? That's easy:

Note that post-recession in 2001 federal spending exceeded the Euro-zone target of 3% continually, hovering between 4-6%. This is in stark contrast to the years prior to 2001, when it was in fact falling - that is, private industry was supporting the economy.

Also note what has happened during the last two years - Federal Deficit spending was 9.65% and 12.11% of GDP, respectively.

Here's the problem - deficit spending like this produces false final demand, in that it implies the ability to do so forever. We of course know this not to be true - witness Iceland and Greece, neither of which were able to continue the charade ad-infinitum. Nor will we be able to; we have survived thus far without "feeling the consequences" because others are willing to loan us ever-increasing amounts of capital at ever-lower rates of interest.

So what does this look like overlaid? That's pretty simple too:

Your green line is nominal (as reported) GDP. Deficits are in blue, and actual private economic GDP - that is, the total output generated by private business activity, is in red.

Remember when I said "we will have a Depression" - that given what the government did in 2001-03 timeframe it was inevitable?

We're in one now.

So why has the market rallied so strongly? For the same reason it did in 2003 - the Federal Government has stepped in to replace final demand by consumers and private enterprise. That "stabilization" is neither permanent or healthy - indeed, it always causes malinvestment, where capital is put not into productive enterprise but rather tries to "chase" some sort of speculative return because that is the only game left in town.

In the 1990s there was plenty of speculative froth and lies, but at least people were trying to speculate on something that was real - The Internet and the rise of the personal computer in American Business as more than a tool for word processing in lawyers' offices.

But in the 2000s Government interference in what should have been a 10% drop in GDP prevented it - and resulted in massive malinvestment in the speculative froth in housing. Fact is that the actual economic value of a home does not rise or fall - it is a place to sleep, hang your hat, take a shower and cook dinner. The "multiplier" beyond that - that is, all alleged "value" beyond shelter, is pure malinvestment. Government and The Fed encouraged and stoked it with a "free money machine" - not from The Federal Reserve but from the fiscal side of the table - that is, from Treasury and Congress.

Now we're doing it again, writ large.

Consider this - we're spending nearly 12% of GDP in borrowed money that we don't have. Last month we borrowed and spent $333 billion - that is 28% of GDP!

Got that yet? Government borrowing was nearly one third of the economy last month!

Now I'm quite sure that next month will show marked improvement. It always does, being April (tax day) and all. But marked improvement doesn't change what's going on here, nor the actual GDP of the economy - not what the BEA reports, but what private supply and demand produces.

If you believe that we can continue to hold GDP at a positive "reported rate" while spending 12% of it via deficits, or even half of that, you're welcome to believe that. But history says that the crash that comes as a consequence when the imbalances build to the point that something breaks takes the market and economy lower that it would have gone had the intervention not been applied.

What we're doing now is unprecedented, other than during a global war (e.g. WWII) when it was literally "buttholes and elbows" together with the entire nation laboring for one purpose - to avoid obliteration.

To apply such extraordinary "stimulus" via borrowing other people's capital simply to avoid having those who made malinvestments being forced to declare bankruptcy, thereby resetting valuations of all items in the economy to sustainable levels, is both outrageous and doomed to fail.

We can argue time frames, but what can't be argued is the outcome. We must stop this insanity, as we are building up even greater distortions than we had in 2006 and 2007 - indeed, we have managed to take five years of insanity (2003-2007) and compress it into two!

Does this mean we're due for it all to blow up now? Not necessarily, although it might. But it does mean that the damage when it does come apart will be at least as bad as it was in 2008 - and this assumes we stop today.

We will not, of course, which is why one needs to be prepared for what is inevitably to follow when the government's ability to continue this charade is interrupted, whether by forces within or without.

How Far Down The Rabbit Hole Must We Go?

nospam@example.com (Karl Denninger) — Sun, 21 Mar 2010 22:38:01 -0400

.... before our citizens - and government - wake up?

If you remember in October of 2008 I put forward the following:

The Truth is that we now require about $5 of debt to generate $1 of GDP.

The Truth is that the reason you were not asked to approve $700 billion to capitalize 10 new banks, thereby creating seven trillion in lending capacity is that the economy cannot soak up that new lending capacity; each dollar of new debt generates almost no aggregate GDP. If this were not true then that would be the logical and effective cure for the 'credit crunch" - if the borrowing capacity and impact on GDP necessary to help existed. They do not.

The Truth is that you were lied to about the purpose of the TARP/EESA, because what you were sold was mathematically impossible. It is supposed to be unlawful to lie to Congress.

As I pointed out at the time, the reason they didn't create that $7 trillion in new credit issuance is that there was no more capacity to take on new debt in the private sector.

They knew it.

They lied about what "had to happen" for stability to be restored.

They lied because the alternative was that their friends - powerful friends - would have to go bankrupt.

But it gets worse. Some of the other points:

The Truth is that the absolute worst thing you can do when "in the hole" like this is to spend even more on a deficit basis, thereby driving the debt ratio higher and return-per-dollar-of-debt in GDP lower. The last eight years have been disastrous in this regard.

Yet that is exactly what we have done - we have replaced fully 10% of private GDP with public spending, and while the claim was made that this is "temporary" the CBO says it is not, Obama's budget says it is not, and the credit contraction that is continuing in the private economy says it is not.

Bernanke and Paulson, and now Geithner, know that this attempted "reflation" won't - and can't - work. They have put forward this path not because it is the right thing to do, but because the alternative means a lot of people with power and money will go bankrupt and the Government of The United States will have to change how it finances itself, removing the corrupt influences that have been used to "cook" the books - and outcomes - for the last 30 years.

We have blown three trillion dollars since these intentionally-wrong decisions were made, and we will continue to blow more and more money until the entire banking and economic system collapse unless we change course.

Nate has updated the debt-GDP contribution chart that I posted back in 2008 (and which was originally generated by Legg-Mason - it's not difficult to generate it from the Federal Reserve Z1) and it shows exactly what I was predicting - and why the policies of the government and Fed not only haven't but can't work:

Now let's be clear: Essentially all money is debt in our current system. As such attempting to "print" your way out, or attempting to "inflate" out, or attempting any act other than forcing the default of the bad debt in the system results in digging the hole deeper and deeper - that is, depressing private GDP further.

Government's efforts have not helped, they have destroyed the four years we had before "zero hour" was reached. Bernanke's interference in the mortgage market didn't "help" that market, he effectively entirely replaced the private market. The Government's "interference" in the private markets by borrowing and spending $3 trillion over the last two years - more than 9% of GDP annualized - is an attempt to "paper over" the insolvency of private actors in the markets - both borrowers and creditors.

These acts of interference did lead to a huge stock market rally, but just as with all forms of cooking the books they are false dawns and false hopes. They present a picture of "solvency" that does not actually exist. They present a picture of private demand in the economy that does not actually exist.

Since we are now below the "zero line" of GDP-contribution from further debt issuance we simply tighten the monetary flat spin by trying to further print or deficit spend.

The chart in the above link has been updated, of course. It now looks like this:

Despite all the printing, despite all the borrow-and-spend politics each new dollar of currency is representing a decreasing monetary velocity multiplier - that is, we now get less than one dollar for each dollar - the real rate of return is now NEGATIVE.

As in a flat spin in an aircraft, you cannot pull up and live. All pulling up does (printing or borrowing more money) is tighten the spiral. I identified this crossover in December of 2008, and warned of it months earlier.

We have tried it Bernanke, Paulson and Geithner's way and it has failed.

We will strike the ground unless immediate corrective action - that is, pushing forward on the stick - occurs.

Taking that corrective action will cause us to lose altitude faster for a while. If we wait until the ground is "too close", we will strike the ground and (economically) die. The precise point where there is no longer enough time (altitude) is not known in advance, but that we have far less margin now, more than a year later, than we did in December of 2008 is a mathematical fact.

To halt this process we must take the following actions now:

All direct taxes must be scrapped immediately. This means implementation of something like The Fair Tax. I fully understand the political ramifications of thousands of lobbying firms and individuals losing their ability to game tax code, and why this sort of reform is unpopular with the political class. Politics must give way to mathematics; the government must align its revenue with the promulgation of actual business success as measured by actual consumer final demand. In addition such a change, while radical, would cause an immediate rush into America for the world's business headquarter locations, and with those businesses would come high-paying executive, administrative and manufacturing jobs. This proposal is an actual bill (HR. 25 / S. 296) which means it can be moved and passed. We just need the political will to do so.
ALL government support for insoluble debt must be removed. This means restoring mark-to-market, barring all off-balance-sheet activities and deeming that loans such as HELOCs behind underwater, non-performing firsts be written to recovery value (which in most cases is in fact zero.) I understand that this will expose the existing insolvency of some very large financial institutions. I also understand this is very politically unpopular for obvious reasons. It does not matter; this has to be done.
Banks must be required to hold Capital Reserves equal to 10% of their outstanding assets that are secured and 100% against all unsecured loans. This will cause even more insolvencies, but it will instantly clean up the banking system. Provide a six month time period for all institutions to come into compliance with (2) and (3), with no extensions, and mandate that any firm that does business in the US must comply - no exceptions. Going forward the 10% capitalization level (for secured assets) must be monitored and maintained as a "warning level" and firms must be liquidated at 6%. This will guarantee in the future that the FDIC will never a take a loss on the deposit insurance fund.
Treasury must then use the existing authority under The Constitution to issue non-debt-backed dollars. This does not require new legislative authority - all existing coins are in fact not debt-backed! Treasury can thus issue fiat, non-debt-backed currency under existing authority - it has simply refused to do so! This use should be restricted to funding FDIC pay-out requirements for the firms that become insolvent under this reform process. This issuance - if limited to FDIC payout coverage - will not be inflationary as it will exactly balance the deflationary force of default on the debt caused by those insolvencies.
An expedited, one-time bankruptcy provision must be made available to consumers so they can enter and process against an expedited Chapter 7 liquidation. It is essential that we permit consumers to de-leverage back to sustainable levels. Points #2-4 will insure that banks that fail as a consequence will have their depositors covered.
Credit-Default Swaps - or any other form of derivative - must be forbidden unless exchange-traded with a central clearing and margining counterparty that exposes all information to the market, including bid, offer, size and open interest. That counterparty must be the buyer for all sellers and the seller for all buyers, as is done today by the CFTC and OCC. Those firms that cannot post cash margin against their open, underwater positions must tear them up within 180 days. Speculation is fine - provided you can prove you can clear the trade! Again, any firm that wishes to do business in The United States must comply in all markets, or be barred from our markets. Once again this may produce insolvencies but point #4 will (again) guarantee that all depositor guarantees are covered.

Government is enacting "health care reform" today not to reform health care, not to provide health care, but rather to impose an immediate tax on all Americans to attempt to pull up even harder on the monetary stick.

It won't work folks. It can't work. More than 18 months ago I identified the primary failure in the path that was being taken, and why. We have tried it Bernanke, Paulson, Geithner, President Bush and President Obama's way now for nearly three years, and yet there has been no resolution of the debt problem, no resolution of the housing market and no actual economic growth. Instead we have papered over insolvency and lied about the health of both our banking and economic systems.

Meanwhile the cracks in the dam continue to grow. Greece is not just "one little problem" over in Europe. Behind Greece is Spain, Portugal, Italy, Ireland and even Great Britain. None of these nations have yet taken the actions necessary to resolve the problem, for the same reason we have not - it is politically very difficult to tell the entrenched banking interests "you must eat your own cooking - even if you choke on it."

We still have time to choose between bad and horrifically awful. We can choose between recognizing the Depression we are already in (private GDP has contracted by more than 10% from the peak, which is the definition of economic Depression) or we can risk Zombieland or Mad Max becoming reality.

Since Europe and the rest of the world show no desire or expectation to do the right thing, we must either firewall ourselves off from their collapse or we will inevitably go down the bowl with them.

We are risking severe civil unrest and the possible destruction of our republic by our continued refusal to face the mathematical facts, not just a "double dip" recession. What Greece and other nations are seeing now is nothing compared to what is on the horizon and will reach us if we do not act.

Mathematics yield to no political desire or arrogance wielded by man or woman. Those relationships described by mathematics inexorably come to pass, unless you change the equations. In a debt-backed fiat currency world continuing to load debt into a system that has too much debt in it related to production is a futile and self-destructive act, just as is an alcoholic deciding to chug yet another bottle of whiskey.

Economically we are facing liver failure and brain cancer unless we stop gorging on our drug of choice - debt. Whether the consequence of ceasing to do so is politically expedient or not is, at this point, immaterial. We are literally gambling with the ability of this nation to continue forward as a going and peaceful, civil concern.

We still have time to act and do the right thing to halt what will befall us should we continue on our present path, but that time is running out.

Whadda 'Ya Mean It's Not Over?

nospam@example.com (Karl Denninger) — Wed, 03 Mar 2010 09:33:00 -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.