HOW WE'RE GETTING RIPPED OFF

OK, I've been writing for some time now about some of the smoke & mirror games that allows Wall Street's biggest financial players to "privatize the profits and socialize the losses." To do this, they've been dumping their toxic - or close to toxic - assets on the American taxpayer, and securing good money for their efforts. Two of ways that Wall Street has been doing this include:

1. Using shaky contracts as collateral for government-backed loans.

2. Revaluing shaky contracts above market price to make these loans bigger than they should be.

If you want to know the technical terms and details behind these deals go to this post from Yves Smith at nakedcapitalism.com. All of the stuff she posts is a treasure trove of insight and information. This post, however, is dedicated to simplifying (oversimplifying?) the details.

Let's say you acquire a car. You expect to make lots of money racing it. You also expect to sell it later as a classic. The car makes you look edgy. You have lots of friends. All is good.

But then things go bad. You wreck the car in a multi-car crash. Your car is still drivable, but you're not going to win any races any time soon. You now have no friends.

Even if you fix the car, problems will arise because of questions about the frame, replacement parts, etc. But things become even worse because people know that you wrecked your car in a demolition derby, where everyone else was trying to win races, just like you.

No one wants the cars that were in the derby. So sad.

The market for cars in general isn't good. But the market for wrecked cars in the derby you raced in - no matter how nice they were to begin with - is even worse.

Now imagine going to a bank and saying, "Give me a full value loan on my fine auto ... it will be worth much more once I fix it." In the real world, this is the response you should expect to get ...

But in our "privatize the profits, socialize the losses" world the Federal Reserve has figured out a way to help you (i.e. Wall Street) out. The Federal Reserve created a Primary Dealer Credit Facility (PDCF) where owners of wrecked vehicles can use their cars as collateral to get a loan. And, just like that, based on the original promise of the car (and your promise to fix it), your racing investment is now worth something.

But no one is quite sure how much a car from the demolition derby - even the ones that escaped major damage - might be worth. Still, you're confident, because The House (the Federal Reserve) is letting you sit at the tables, with their money. They're going to be helpful. Your derby friends return.

Suddenly, things get even better. Since the car is drivable, and you promised to fix it, the Federal Reserve's PDCF window allows you to value the car according to what you think it's worth - or what you think it should be worth - once the market for your wrecked vehicle improves (this is the concept behind "mark-to-market"). Cha-ching ...

You leave the car with the Fed as collateral, and walk out with some real money.

Do you return for the car, and pay back the money? Wouldn't it be so much easier to leave it with the Federeal Reserve? You've got the money, right? Instead, because there are no penalties for being reckless, you go out and buy another car, and do it all over again. The Federal Reserve American taxpayer has to eat the losses on the collateral you left.

In many instances, this is what we're going to end up with on many of the collateral contracts the Federal Reserve the American taxpayer is absorbing through the Fed.

While all of this may be an oversimplified version of what's going on, it makes the point. We're taking on toxic instruments, and exchanging it for good money. But most Americans don't have a clue about any of this because of the complexity behind Iron Maidens, market-to-market accounting, CDOs, etc.

This is why greater transparency about the what the Federal Reserve is doing is necessary. They're not giving up enough information now, which makes the details even more fuzzy. Worse, because there were never any penalties for reckless behavior in the first place (the behavior was rewarded), we may be setting ourselves up for another financial demolition derby.

Stay tuned.

- Mark