Tuesday, August 6, 2013


It appears that the financial engineers learned nothing from the market stupidity that led to the 2008 market meltdown. They're setting us up for another financial train wreck. Check this out ...

One of the biggest problems we saw with the market meltdown was tied to market players (they're not investors) who thought they were masters of the universe because of the "brilliant" debt drenched money making schemes they developed.

At the heart of the money making plans were easy money and flimsy investment instruments - derivative products - that only paid out if millions of debt laden consumers kept their jobs and made regular payments on their debts. To convince themselves that they had a sure thing market players got the ratings agencies to give their products AAA ratings, then went out and purchased insurance (Credit Default Swaps) from unregulated groups that, as it turns out, didn't have the money to pay out claims when the s**t hit the fan.

With flimsy investment instruments backed by a faux insurance regime market players proceeded to borrow lots of money, which they could do in an era of deregulation, to make trillions of dollars in market bets.

And why not? Then Federal Reserve Chair Alan Greenspan had blessed the debt fueled financial engineering, bragging that the wizards on Wall Street had created a "new paradigm of active credit management."

Then, in 2008, the market collapsed on its own nonsense. Oops.

The global firms and institutions that got caught up in the 2008 market collapse lost hundreds of millions, with larger institutions losing many billions more. Fortunately for the financial institutions who lost money from around the world the skewed bailout culture (that was led by the United States) also included favorable legislation and generous tax write-offs from their home countries.

Perhaps one of the biggest favors was allowing the foolish market players, who got caught up in the debt and derivatives mess, to deduct their losses from future earnings. This saved many firms from bankruptcy, and many more individuals from financial ruin.

Among the many firms and institutions that got caught up in the debt drenched mess were banks in Spain. They borrowed from international markets and fueled the Spanish real estate bubble, which popped in 2008. But the banks in Spain now have a problem. As part of the larger global effort to clean up the market mess, Spanish banks - per Basel III - are supposed to have more cash reserves on hand. The banks don't have the money.

This is where it gets fun.

Spanish banks want to take the losses that they absorbed after 2008 and convert them into hard cash assets. How do you convert a monetary loss into hard cash, you ask? Simple, you get the government to sign off on turning your future tax deductions into hard cash today. Banks in Spain are currently petitioning the Spanish government to "advance" them future tax deductions with billions in credits.

All of this will be paid for by the Spanish taxpayer, of course.

Specifically, with about $65 billion in losses (a little more than 50 billion Euros), Spanish banks are asking the government to turn about two-thirds of their $65 billion in losses into bank credits. For this to happen the Spanish government will have to credit each private bank account with billions out of government accounts. Call it Financial Engineering Dos Punto Zero.

At issue here is whether the Spanish government - which has serious financial problems of its own - can afford to credit the banks the money they want.

If you're looking for an analogy to what the Spanish banks are asking for think of an average home owner in the U.S. who's paying off their mortgage. Tax law in the U.S. allows homeowners to deduct a large portion of the interest they pay on their mortgage loan. If a homeowner deducts $2,000 per year in interest over the next five years the homeowner will receive $10,000 in deductions. If we use the plan outlined by the Spanish banks, instead of asking for deductions over the next five years the mortgage payer in the U.S. could ask the government to front them $10,000.

And just like that the homeowner gets $10,000 because of a neat accounting trick that turns a tax asset into a bank credit.

But wait, if we cross the Atlantic, the creativity behind the financial engineering only gets better.

Remember the flimsy investment products I discussed above? You know, the bundled up mortgage contracts with the faux insurance plans that only pay out if the debtors in the financial pyramid actually makes regular payments. As we know, the debt drenched derivative system didn't work out so well.

Still, in spite of crashing the market with derivative laced bets in 2008 the financial engineers on Wall Street now want to bundle up monthly rent payments, and turn them into new and improved derivative products that they want to sell as securities.

In effect, the financial mandarins of the world are saying to the taxpayers, "So what if the derivative contracts we stacked on top of one another and sold as securities took us into the financial crapper in 2008. We'll have more luck with securitized rents this time because we've worked on the debt-laced kinks ... and yeah, we think you're that stupid."

At the end of the day the financial engineers are at it again. They're still trying to turn straw into gold. In reality, bit by bit, they're setting up our next financial train wreck. And no one seems to care.

- Mark

1 comment:

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