OUR 2008 MARKET COLLAPSE ... ON A GLOBAL LEVEL

Wall Street fell 2 percent today. Many analysts want to blame it on the bleak jobs report. My friends, it goes beyond that.

For years now - in my classes, in numerous posts, and in private presentations - I have argued that history is whispering in our ear. In a few words I have tried to point to the conditions that have led to economic collapse and political breakdown in the past. Then I explain how these conditions are being recreated today.

Politically and economically a perfect storm is on the horizon.

There are many indicators that I discuss in my book, in my classes, and in my blog posts (which will also appear in my next book). Still, one thing is clear: the hedging, gambling, and artificial markets that have been created on a pile of debt have been made worse by successive bailouts and favorable legislation.

I bring all of this up because of this post from Zero Hedge. It directs us to what the founder of Global Macro Investor, Raoul Pal, has to say about the looming perfect storm. He agrees with what I've been saying for years and it's not pretty.

But unlike other investor windbags trying to scare people into investing with them Pal succinctly outlines what been happening to the global economy and leaves it at that. In a few words he writes that this looming perfect storm will soon become our reality because:

[t]he problem is not Government debt per se. The real problem is that the $70 trillion in G10 debt is the collateral for $700 trillion in derivatives ... Yes, that equates to 1200% of Global GDP and it rests on very, very weak foundations.

Translated what this means is that the combined debt of the largest economies in the world totals about $70 trillion (as a point of reference, in 2012 the entire U.S. economy will produce about $15 trillion in goods and services). The world's financial players have placed about $700 trillion in bets on this debt. Put another way, $700 trillion in global hedging and gambling rests on a pile of debt.

Worse, because that debt is unstable (think Greece, Portugal, Spain, Ireland ... EU ... England ... etc.) it effectively rests on a weak and largely artificial market.

In more practical terms, what happened in the U.S. economy in 2008 is now being done globally. And it's all made possible, in part, because successive bailouts and favorable legislation have anesthetized our political and financial leaders to the market stupidity we've created and engaged in over the past 30 years.

Raoul Pal thinks we have about 6 months left before the house of cards comes tumbling down. Definitely by 2013 he argues. I'm not so sure about the dates.

But rest assured, we're f**ked.

- Mark

THE FINANCIAL STD HANGING OVER EUROPE

Let's say you earn $21,000 per year. Would your bank grant you credit and loans that total more than $600,000 to "invest" on long shot bets in Vegas? Sounds ludicrous, right? And it is, until you realize this is how our global financial system is currently structured.

Thanks to some fancy (but rigged) modeling of market instruments, market players have been able to convince some incredibly stupid people (though there are some smart ones in the bunch) that their bets will pay off. What the incredibly stupid people don't understand is that the entire house of cards can only function if lines of credit are kept open. The problem here, as Hyman Minsky warned, is that it's one thing to borrow when you have the assets to back things up, but it's an entirely different thing to borrow when the collateral is full of financial holes.

This is precisely the situation Europe faces today, and why efforts to fix their banking system will fail.

Mirroring what I've been writing and talking about for years, Money Morning's Keith Fitz-Gerald explains why Europe's banks are going under, in spite of the the seemingly never ending trillion dollar rescue efforts from the U.S. central bank, and others. Specifically, Europe's financial system is confronted by three big challenges.

UNCERTAINTY: Thanks to the murky system of cross derivative (i.e. Vegas-like) bets European Union (EU) ministers are reluctant to put money into a banking system that has the financial consistency of Swiss Cheese (why Ben Bernanke is doing it is another issue). And they should be reluctant. Because derivative markets are so murky, the ministers don't know how much is going to be needed, or who's going to need it.


FINANCIAL STDs: Because of the cross pollinization of derivative bets even healthy banks have been exposed to the financial STDs of the financial world. In what will (no doubt) be described as a pre-emptive effort, all banks will be provided with back up funds just in case (i.e. when) their partners drag them under. It's kind of like an STD screening. But in this case you get the penicillin shots too (a process that resembles the U.S. banking "self-esteem" efforts too).


GOOD MONEY GOING AFTER BAD: Money from strong banks will be diverted to weaker banks. This is bad news. Why? Because in order to backstop the bad bets, even bigger (worse?) bets will be placed because they offer the promise of higher returns. This will only serve to keep the derivative lunacy going until the stupidity collapses on itself, again.

So why is this all a problem? Because the banks have lent or provided $600 trillion against market (derivative) instruments that are valued at $21 trillion. Total exposure here is 28.4-times. Go into a bank and ask them to provide you with a loan or credit totaling 28 times what you earn/own.

The bank's rationale for rejecting you is exactly why the financial stupidity in Europe cannot be sustained.

- Mark  

P.S. If you want to know how derivative bets get started click here.

THE "BIG LIE" CONTINUES

Early last week I posted on the GOP presidential field and their penchant for blaming the housing mess - and subsequent 2008 market collapse - on government policies. Long story short? Calling on my inner Paul O'Neil, I commented that the candidates in the GOP field are acting like blind men in a room full of deaf people. I posted links to earlier posts and op-eds I've written on the topic to provide substance and background.

Today I ran into this Washington Post discussion on the market collapse by Barry Ritholtz. It's titled "What caused the financial crisis? The Big Lie goes viral."

In a few words, Ritholtz makes the same points that I do, and argues persuasively that - rather than admit error - there is an emerging industry out there bent on creating a new narrative. Not only is this new narrative full of lies but, unfortunately, it's also winning the day.

 
Challenged on his op-ed points, Ritholtz responded with this piece in the Washington Post. It's excellent. I encourage you to read both his Nov. 5 and Nov. 19th columns. Both have inspired a great deal of ill-informed push back.

According to Ritholtz, the "push back continues from the usual sources." He lumps the Know Nothing sources into "3 distinct categories" that tell us much about a larger "disturbing trend" in America:

1) The Cognitive Dissidents (my term for a those politically dissenting from reality); their brains simply will not allow them to see what disagrees with their ideology. This is a very real and unfortunate part of human nature;

2) The Political Manipulators, who cynically know what they peddle is nonsense, but nonetheless push the stuff because it is effective. These folks are more committed to their ideology than the good of the nation, and as such earn my disdain.

3) The Innumerates, the people who truly disrespect a legitimate process of looking at the data and making intelligent assessments. These innumerates — mathematical illiterates — seem to revel in their own ignorance; it is embarrassing.

Ritholtz adds, "denying of reality has been an issue, from Galileo to Columbus to modern times. Reality always triumphs eventually, but there are very real costs to it occurring later versus sooner . . ."

I couldn't agree more.

- Mark

THE GOP FIELD ... LIKE BLIND MEN IN A ROOM FULL OF DEAF PEOPLE

Republican presidential candidates are ignoring reality, again.

Ten months ago I wrote that the GOP would - against all the evidence - begin blaming the government for a housing mess that was largely caused by the private sector and Alan Greenspan's policies. I wrote about it again in June. So, what happened last week? GOP presidential hopefuls blamed the real estate mess on "the government."

Like Paul O'Neill's blind man in a room full of deaf people, the GOP field ignored the role "Wall Street," "deregulation," and our "shadow banking" system played in creating the conditions for our housing market to bubble and burst. Nice.

But none of this should come as a surprise. GOP operatives began laying the groundwork for this narrative ... last December. Like last year's GOP operatives, todays Republican presidential hopefuls ignored the following:

* Freddie Mac and Fannie Mae were privately managed (and even became one with Wall Street) during the worst period of the housing bubble and bust.


* The real estate bubble and crash was global. Freddie, Fannie and the Community Reinvestment Act aren't global.


* Our commercial real estate market bubbled and crashed, too. Housing policies concerning Fannie, Freddie and the CRA had nothing to do here.


* Federal Reserve data reported that more than 84 percent of subprime mortgages in 2006 (right before the crash began) were issued by private (shadow) lending institutions. Yeah, that's 84 percent.


* Of these, only one of the top 25 subprime lenders in 2006 was directly subject to the housing laws like the CRA.

For added measure, here's what Federal Reserve Chair Ben Bernanke had to say about the real estate bubble and crash: 

"(M)ore than 30 years and recent analysis of available data, including data on subprime loan performance, runs counter to the charge that CRA was at the root of, or otherwise contributed in any substantive way to, the current mortgage difficulties."

And the GOP's vaunted free market claim? Their record's not good here either. Back in 2003 Republicans began praising subprime lending as the type of innovative lending that comes from deregulated or unfettered markets. Again, they praised subprime lending that led to low quality mortgages.

But this isn't the worst of it.

The real story here is how Republican members of Congress actually used Wall Street talking points to criticize Freddie and Fannie in the lead up to collapse. They did this because it helped AIG, Goldman Sachs, Lehman, Merrill Lynch, etc., muscle in on Freddie and Fannies market share (between 2004 and 2006 Fannie and Freddie went from holding a high of 48 percent of the subprime loans to about 24 percent).

After dumping many of these products on unsuspecting clients, Wall Streets economic mandarins are now dumping many of these toxic ("legacy") assets on the American taxpayer, in exchange for cash payouts.

You won't hear any of this from the GOP list of presidential candidates. Ever.

- Mark

WHY THE MARKET CRASHED IN 2008 (in 10 easy to understand steps)

Arrgh ... If I hear one more GOP presidential hopeful blame our current market mess on President Obama again I think I'm going to have a brain aneurysm. To be sure, I understand the political part of what the candidates are doing. What gets me is how so many Americans buy into the ignorance and stupidity, and it's starting to burn through the electorate like wildfire ...

I bring this up because people speak as if President Obama could have somehow waved a magic wand and fixed the economy in just three years. Apart from having to deal with a "just say no" GOP, what they forget is that it took the better part of 6 years for the Bush administration and a GOP-led Congress to blow through budget surpluses and set the stage for burning down our economic house.

Destroying the peace and prosperity that was left to President Bush took some real effort and incompetence, and can't easily be undone.

So, in an effort to dispel any notion that President Obama is to blame for our current mess (though, I agree, he screwed up on bailing out the banks), I'm going to present what I hope is an easy ten point overview of why the market collapsed in 2008. What you'll see is that our current economic mess didn't happen over night, and won't be turned back over night either. I'm drawing the information straight out of my book. So if you want more information go out and buy my book (I know, shameless plug).

As you'll see, there's enough bi-partisan stupidity to go around, though one party definitely deserves more blame than the other for our current mess. You can quibble with the 10 points (I might even emphasize one point over another in the future), but the general outline of our market collapse, and what ails our markets today, are here.

Anyways, here goes. Our market collapse, in ten easy steps ...

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THE BEGINNING

1. A Naive Belief in "Free Market" Ideology (blinds policymakers)
... Ronald Reagan enters the White House after Maggie Thatcher becomes Britain's Prime Minister. Trickle Down economics is born. Deregulation, tax cuts for the rich, and globalization are embraced.
... After dumping trillions in borrowed money into the economy Reagan almost triples the national debt, raises taxes on the middle class (FICA), and lifts the debt-limit ceiling 17 times. Yet he's hailed as a fiscal conservative.
... In an effort to concentrate on  "free markets" in the 1980s, U.S. leaders effectively ignore economic costs associated with (1) paying for the defense of the west, (2) America's rude introduction to unbridled globalization (caused, in part, by the success of Bretton Woods), (3) the structural changes in the economy caused by the rise of financial services sector (i.e. the "symbolic" economy), (4) Nixon's price controls, and (4) OPEC's inflation inducing price hikes.
... Instead of dealing with costs of U.S. militarism, competition from abroad, the financialization of the economy, Nixon's price controls and OPEC price hikes, America's leadership blames sluggish U.S. economy on "the state" (regulations, domestic programs, and taxes), while calling for "a good 'ol shot of capitalism" in 1980.

BUILD UP: 1970s-1980s

2. Deregulation / Financialization  of Economy (regulator vacation)
... 1971 the dollar is de-linked from gold and becomes a commodity. Futures markets develop for money, interest rates, and other novel investment tools of the trade.
... OPEC price hikes wreak havoc on markets and prices. Pundits and foreign policy experts alike (see especially Henry Kissinger) are caught flat footed.
... new policies and deregulation pushed by financial services sector make the Savings & Loan debacle possible (1970s/1980s), and help to set the stage for the deregulation stupidity that eventually leads to the dismantling of the Glass-Steagall Act and the passage of the Financial Services Modernization Act (1999)
... financial services sectors consolidates as symbolic economy grows in importance. SEC begins its disappearing act.

3. Interest Rate Manipulation (what free market?)
... Interest rates are used first to stabilize markets, and then as a tool to stimulate them. Bailouts and money dumps begin in earnest under Alan Greenspan's leadership at the Federal Reserve. The Greenspan Put (dumping cheap money into the system when Wall Street gets in trouble) begins in 1987.
... Federal Reserve becomes Wall Street's support system, and then it's puppet.
... Market recklessness surges as financial services (and gambling) grows.

4. Yield Hunts / Secondary Markets (casino economy begins)
... Inflation + low interest rates in 1980s lead bond traders to start looking for higher yield investments.
... Non-traditional investment products become more attractive, but market players are (initially)reluctant because of low bond ratings.
... Globalization (largely unregulated) allows financial firms to seek higher investments abroad through loans, secondary markets, arbitrage, etc.

5. Bailout City (what, accountability?)
... Beginning with Mexico in 1982 (actually it begins earlier, but this is where I'm starting), Wall Street's stupidity is bailed out time and time again. The Greenspan Put begins in earnest in 1987 with LTCM.
... Accountability and free market ideology are undermined with bailouts, but no one cares. Wall Street/investment bankers continue to believe in the wonders of the market.

MANIA: 1990s / Aughts ...

6. Securitization / Derivative Markets Explode (hello Rumpelstiltskin)
... Market players become Rumpelstiltskin, and turn crap into gold. CDOs, SIVs, CDSs, and other novel investment products become popular, especially after ratings agencies get into bed with Wall Street's biggest investment banks. Interconnected market players game the system.
... Wealth extraction becomes more important than wealth creation. What would have been criminal or fraudulent before becomes modus operandi with favorable legislation.
... Security markets begin demanding more products (i.e. debt) to securitize, as rating companies begin to hand out AAA ratings on virtually anything that can be chopped up and modeled.
... Symbolic economy grows 30-40 times the real economy.

7. Toxic Market "Innovations" Applauded (herd mentality for rugged individualists)
... Wall Street (Goldman Sachs then-CEO, Hank Paulson) goes to SEC for permission in 2004 to carry 40:1 debt to equity ratios (Imagine going to a bank and asking to borrow $2 million on a $50,000 a year income). It's granted.
... With demand for securities growing, hedge funds, shadow banks, and Wall Street press Washington regulators to allow "non-conventional" lender packages into the housing market.
... Non-bank, or shadow banks, become critical cogs in financial machine. Subprime mortgage underwriters ignore all lending standards.
... With brokers dumping newly created loans 30-60 days after they're written, NINJA loans, No Doc loans, Liar loans, and other type of teaser programs become the norm.
... Caution thrown to the wind as competent regulators like Brooksley Born are buried politically (after she called attention to disastrous derivative markets), and Sarbanes-Oxley legislation allows Washington/Wall Street to say "See, we fixed it" after Enron. Free market praised as fraud & lack of oversight become the norm.
... Consumers borrow and use homes as ATMs, which give the illusion of prosperity.
... Personal debt climbs; Bush doubles the national debt. Bubbles and record profits grow.

8. The Federal Reserve / Congress Become Cheerleaders (casino economy goes Vegas) 
... Cheerleaders (who should be regulators) applaud innovative instruments and massive (unregulated) lending as evidence of the power of unrestrained markets.
... Home equity loans explode, consumption increases. Debt is the name of the game as it provides source for new securities and credit default swaps (insurance).
... Alan Greenspan cheers "new paradigm of active credit management" as interconnected institutions and the shadow banking system sign off on new securities, mortgage back contracts, and other debt instruments/loans.
... Wall Street and financial services sector pay and bonuses shoot through the roof.
... Notional value of contracts surge past $285 trillion (when annual GDP is only $14 trillion).

PAYING THE PIPER: The Mother of All Bailouts

9. Boom / Bust / Credit Freeze (back to reality)
... What do you know? Strawberry pickers making minimum wage really can't afford $700,000 home loans.

10. Blame Game Begins (continues today)
... Government Secured Enterprises (Fannie Mae), FHA loans, and Community Reinvestment Act (the poor) originally blamed for market collapse. Former Treasury Secretary Hank Paulson joins the game.
... George W. Bush (wrongly) claims he inherited a recession, and left with a recession. Nothing to see here. What a loser.
... Much anticipated bi-partisan FCIC report is blind-sided by GOP primer that deliberately excludes any mention of Wall Street, the shadow banks, interconnected cronyism, and deregulation (all the stuff I highlighted in red above).

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The incredible thing is that we have now come full circle. Today, Republican presidential candidates are full fledged free market ideologues, pushing for more of the same policies that got us into our current mess. Don't believe me? Start at #1 above. Begin reading, again.

Only this time the banks and Wall Street are the only ones who have access to, and are profiting from, unlimited cheap money and our propped up casino economy. Think about it. Today the house of cards (yes, it's still a house of cards) is propped up by cheap money for Wall Street, deregulation for Wall Street, favorable legislation for Wall Street, and adherence to a failed ideology in Washington that keeps the trillion dollar bailout and QE money flowing, for Wall Street.

At the end of the day it took almost a full generation to reach our current level of market stupidity. It's not going to end under President Obama in one term. Especially with the GOP acting like a political boat anchor.

- Mark

SUPERCHARGING WALL STREET, AND AMERICA'S EVOLVING SYMBOLIC ECONOMY

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In my International Political Economy course today we spent a good deal of time talking about the interplay between economics and politics, and how both impact modern markets. Since some of it was a bit detailed, below is a brief outline of some of the topics we discussed in class. Those of you who are not in my class can read too  ;-)
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In International Political Economy class this Monday we briefly discussed what happened when Congress created the 401k (tax deferred incentives to invest), and then encouraged, or allowed, other novel financial instruments to arrive on our economic stage. In the process Congress supercharged Wall Street's numbers, but what we really saw was the evolution and consolidation of what Peter Drucker called the "symbolic" economy, and what Kevin Phillips referred to as the beginning of the "financialization" of the American economy.

What did this mean for America? In a few words the American economy became increasingly dominated by trade in money, interest rates, futures contracts, and other "derivative" instruments. Trade in durable or manufactured goods has taken a back seat to these financial products. In fact, the American economy has been trading in these "symbolic" financial instruments to such a degree that they now represent at least 20 times (and perhaps 40 times) what we will produce and trade in the "real" economy this year (about $15 trillion).

In plain speak - and as economist Joseph Schumpeter might have put it - we are now living in a world where America's economic mandarins are playing monopoly rather than building them. This is the biggest difference between the Robber Barons of the past and our Robber Barons of today.

The Carnegies, Morgans and Rockefellers of the 19th century built steel mills, railroads, and other real industries which created real wealth. If they went bust at least they left railroads, steel mills, and other industries of substance. Not so with today's financial wizards. The Robber Barons of the 21st century are financial zombies bent on extracting rather than creating wealth. It's really that simple.

We can see the impact of America's economic transformation because of the increased emphasis on the financial sector, and because how more and more of Americans are seeing their wages squeezed (see graph below). Unfortunately, this has forced many Americans out of the middle class.

At the same time Americans are watching their incomes collapse Wall Street has focused on safeguarding their empires of paper wealth, and finding new ways to pump up the market. This is one of the reasons we have seen a plethora of financial instruments created and traded. Not surprisingly, total volume traded on the NYSE has exploded since 1982 ...

As should be expected, with every fee-laden trade, and with every new expanded portfolio managed, Wall Street's financial mandarins have gotten increasingly wealthier. This explains, in part, the growing wealth gaps in America.

But volume isn't everything. There's also this. Every time Wall Street's financial wizards created new ways to trade and then collapse the economy, Congress and the Federal Reserve have stepped in with an assortment of bailouts, money dumps, and favorable legislation to save their bacon.

WHAT WE'RE GOING TO DO IN CLASS THIS QUARTER (in part)
While many Americans don't understand the details of any of this, one thing is clear: Our economy is increasingly built around, and dominated by, fuzzy financial instruments that take many shapes. The financialization of America's economy is part of what we'll be looking at in class this quarter. We'll be doing this at a global level too.

As an example of how the financialization of the economy works in the United States we can look at home mortgage loans and other debt contracts (student loan, credit card debt, etc.). Specifically, when we look at what's happened to mortgage contracts we find that they are no longer single documents holding all the information you need to know about a loan. Instead, home mortgages (and other debt contracts) are sold, bundled up with other mortgage contracts, and then resold as a collateralized debt obligation (CDO) security.

Today most mortgage contracts that are bundled into securities and sold can only be understood if you can decipher this ...

While these mortgage backed CDOs make money for market players the thing to understand is (1) how these CDOs created the environment for deregulation and shoddy lending standards, among others, and (2) how these CDOs pushed the financial industry, and our shadow banking system, to ask for more (shady) debt contracts.

These contracts lie at the heart of what brought the economy down in 2008.

The fact that we did little to fix the problems that caused the meltdown after 2008 help us understand how much power and influence the financial sector has in our economy, and why our next market collapse will happen. Also helping us understand how our new economy functions is that, while all of this has been going on, the vast majority of Main Street has seen their wages decline since 1980 while the financial sector has seen their compensation soar ...

Two key components of this new economy include the wonderful world of "derivative" markets and our extremely important "shadow banking" system (which GOP FCIC members pretended didn't exist in their 2010 report). If you can find the time, try and read the links.

These topics are among the many issues we're going to be looking at this fall. I'll have more to say about derivatives, our shadow banking system, and our symbolic economy as we move through the quarter.

- Mark

OUR NATION'S POWDER KEG

Broadly speaking, our nation's economy is in trouble for two reasons. First, we failed to seize the moment and fix what caused the economic collapse in 2008. Second, our largest economic players seem to be paralyzed by ideological stupidity, which surrounds Washington and, to a lesser degree, Wall Street.

It's really that simple.

On one level, as I explained last week, a second market collapse is around the corner because our national economy continues to be threatened by an explosive brew of reckless deregulation, irresponsible tax cuts, and Wall Street's gambling and speculation. For many "investors" the focus is on short term yield and wealth extraction, not wealth creation. What we had before 2008 is essentially what we have today. This is structural, and won't go away with a simple capital gains cut, or with the congress we currently have.

This is our nation's economic powder keg.

The short-term factors that will light the powder keg are tied to three institutions that can put significant financial resources into action, but are paralyzed by ideology and each others inaction.

Specifically, as we saw during the debt ceiling fiasco, we now have a House of Representatives that's governed by historical and economic illiterates. The GOP's (deliberate) failure to understand cause and effect explains why they're ignoring how we got into this mess, and are doubling down on their "Let's-get-Obama-so-say-no" strategy. They're using our nation's debt (which Reagan tripled and Bush II doubled) as a political weapon, and will continue to fight President Obama on any program of substance, regardless of what it will do for the economy.

The GOP wants President Obama to fail, and don't care if they take the country down in the process. It's that petty.

This extremism is one of the reasons John Boehner and Majority Whip, Kevin McCarthy, couldn't round up enough votes for a debt ceiling deal that the GOP wrote, and then had to rely on former Speaker, Nancy Pelosi, to get the votes they needed to avoid default. The Tea Party and their GOP hosts don't want to give the president anything, and are prepared to wreck the country in the process. It's not Sherman, but it's scorched earth policy at its political best ...

Then we have the private sector sitting on trillions of dollars, much of which (especially for the banks) was made possible because of taxpayer backed bailouts and stimulus programs. Ingrates.

Throw in the fact that the Federal Reserve decided not to inject more money into the economy last Tuesday (in part because the Fed is staffed with ideologues), and it's easy to see why we're virtually guaranteed another recession, or worse.

So there you have it. On one level we did nothing to fix the problems that caused the 2008 market meltdown. This is the powder keg. On another level we're watching as the biggest institutions with the means to help our nation - the private sector, the Federal Reserve, and Congress - sit on the sidelines. They are the kids playing with matches.

Unless something significant happens to change these dynamics over the next two years, I can't seem to find a silver lining in any of this. I hope I'm wrong.

History suggests I'm not.

- Mark

THE FINANCIAL SYSTEM IS RISKIER TODAY ...

Does the financial system pose an even greater risk to taxpayers today than before the crisis? According to analysts at Standard & Poor's the answer is "yes." Specifically, because of accounting tricks, increased derivative exposure, and faulty reforms, the market watchers at S&P "believe the risks from the U.S. financial sector are higher than we considered them to be before 2008."

Put another way, the banksters are stilling looting the joint.

To be sure, the S&P is the same group that saw nothing, and did little to reign in the banksters speculative euphoria on Wall Street before 2008. Still, the good folks at the S&P believe that the next rescue "could be about a trillion dollars costlier" because the level of global interconnectedness now tie firms "to one another in ways experts do not completely understand."

Still not sure what this means? Let's use a metaphor.

What the S&P is saying, in layman terms, is that if you thought Charlie Sheen was a mess during his last meltdown, imagine him on an untreated syphilis-induced drinking binge, with no goddesses. Yup, they think it's going to be that bad.

Here's why ...


THE BANKS BOOKS: Like Spain many of our banks are still in trouble because they are under-capitalized, while our banking system remains dogged by delinquent bubble-era loans.

INCREASED DERIVATIVE EXPOSURE: The rise of globalization and the continued growth of derivatives -- financial instruments that are supposed to spread risk -- have seen their notional value grow to between $450 trillion and almost $700 trillion ($191 trillion for the commercial banks alone), and led to greater exposure between countries, industries, and companies. 

FAILED REFORMS: Global financial market remains fragile due to weak policies, lax regulation, poor accountability and systems that are not designed to capture global risk management.


Think about it. Banks have still not accounted for losses on poorly-performing assets they're hiding on their books, while many of the world's economies aren't as strong as they were just a few years ago. All of this means that when another market collapse happens (and it will) lawmakers will be hard-pressed to convince taxpayers to backstop another bailout.

Because the banksters are doing the same thing they did before the collapse, according to the S&P, we're in trouble.

- Mark

I'M A MARKET GURU

What do you know? I'm a market guru. If I put my tinfoil, Fox News analyst, hat on here's how I know ...

Ultraconservative market newsletter "newsmax.com" had this to say about market "guru" Robert Prechter.

... Prechter sees a plunge ahead for stock prices. The reason is because investors have turned way too bullish [confident] ...

According to Newsmax, then Prechter lists the tell-tale signals that tell him trouble's around the corner:

• Individual investors are the most bullish in six years ...
• Newsletter advisers are the most bullish in seven years ...
• Futures traders are the most bullish in four years ...
• Mutual fund managers are the most bullish ever ...
• Hedge fund manager are the most bullish ever ...
• Economists are unanimously bullish ...
• Top global strategists on three national panels expressed bullishness.

In other words, according to Prechter we have a bunch of market players who, once again, are confident about the prospects of the market (keep in mind these guys get paid commissions and bonuses only if they make their clients so confident that they invest their money with them). And, with their confident "nothing's-in-it-for-me" objective analysis, they've convinced their clients too.

So, collectively, according the Prechter, market players and their clients are swallowed up in yet another market herd stampede.

But, with Americans jittery about their individual prospects, and with the economy on shaky grounds, why all the confidence? What, in God's name, could have triggered this "bullish" herd mentality from today's market players (who, again, get paid big bucks only if they get people to believe markets are growing)? Is it tied to improving market fundamentals? Is a new tech driven boom on the horizon? Could the world be poised for the next super market innovation?

Interestingly, None of the Above.

What's driving this current bubble cycle - according to Byron Wien, vice chairman of Blackstone Advisory Services - is the Federal Reserve's trillion dollar money dump over the past two and a half years. But what's really made the market players bubbly is how this money has been "recycled into stocks" and onto Wall Street's books.

That's right. Because the federal government has been dumping money into the economy for years now - euphemistically called Quantitative Easing (QE I & II) - market players have regained their confidence. And why not? They're making record profits, again. Their mojo is back. In fact, the money dump has worked so well (for America's moneyed elite) that the GOP is even looking for "novel" ways to continue the money dump, but hoping nobody notice what they really want to do. 

At the end of the day, the goal of dumping taxpayer backed money into the economy is to prop up Wall Street. Market gurus like Robert Prechter and Bryon Wien know this. They also know that if the money dump stops we're all in trouble. Market guru Prechter even predicts the stock market could drop 40% (if we don't get another big money dump - or QE III - I have no problem with this number).

The interesting thing is that I've been saying all of this for years. I guess that makes me a market guru too ;-).

- Mark

A STROLL DOWN MEMORY LANE

I smell a rat. After being told by Wall Street that their stupidity and greed were not to blame for the market collapse in 2008, we are once again being treated to big interconnected financial players saying they don't pose a systemic risk - in spite of the fact that they are much larger today than before 2008.

One would hope market players feel this way because Wall Street no longer follows off-the-books, smoke & mirrors, debt bomb, strategies like this any longer. Think again.

As I've pointed out here, here, here, and here Wall Street is still betting the house, recklessly. So, with all the "recovery is around the corner" happy talk starting to come out of Wall Street again, I think it's time that we take a stroll down Wall Street memory lane (courtesy of the Daily Show) ...

* March 11, 2008: Jim Cramer, "Bear Stearns is fine, do not take your money out ..."

Bear Stearns collapsed six days later.

* April 17, 2008: Market experts, "Will Merrill [Lynch] need to raise capital? No ..."

Five months later Merrill Lynch ran out of money, and is now owned by Bank of America.

* June 5, 2008: Market experts concur, "Lehman Bros. is no Bear Stearns ..."

Lehman Bros. went under three months later.


Want more pre-collapse Happy Talk? OK ...

* October 31, 2007: Jim Cramer, "You should be buying things ... and accept that they're over valued ... but accept that they're going to keep going higher ... that's how you make money" (Dow 13,930).

* February 1, 2008: Jim Cramer, "That's why the market just won't quit ... no matter how poorly companies are actually doing" (12,743).

* April 16, 2008: Kudlow & Company, "The worst of this subprime mess is over" (Dow 12,619).

* November 2008: Market experts, "People are starting to get their confidence back" (Dow 9625).

So, how wrong was former Fed Chair Alan Greenspan before the market collapsed in 2008? Let's just say his Utopian view of markets left even him in a Inspector Renault-like state of shock after he discovered how they really worked ...





Which begs the question, how wrong was current Fed Chair Ben Bernanke? Check it out ...





One of the sadder parts of this emerging story-line story is how the media's Talking Heads - the people who are supposed to be the Fourth Estate - acted like a bunch of gushing children, buying into everything corporate America, and the Fed's Gods of Wealth, told them about markets then ... and now.

In a few words, we're screwed. Don't buy into the happy talk. Especially when we're taking a stroll down memory lane, that delivers us into a financial dead end.

- Mark

REPUBLICAN REPORT IS A JOKE

We know that with the helping hand of favorable legislation from Washington that Wall Street gambling and greed are primarily to blame for the 2008 market meltdown. Still, as the Huffington Post's Shahien Nasiripour wrote about last week, all four Republican members on the the Financial Crisis Inquiry Commission voted to exclude the following terms from the commission's report: “Wall Street,” “deregulation,” “shadow banking,” and “interconnection.”

This is like saying we're going to study welfare fraud but we're not going use the words "welfare" or "fraud." It doesn't make sense.

The good news is that the rest of the commission members didn't want to go along with the Republican charade. The bad news is that the Republican commission members - which includes our previous local Congressman, Bill Thomas - decided to write their own Republican report.

Don't believe me? Check it out here.

For those of you who don't have the time to read the Republican Report, or who are unfamiliar with Washington-speak, let me break the report down for you: The market collapse was the government's fault ... but mostly it was Fannie Mae and Freddie Mac's fault.

Even though blaming Fannie Mae and Freddie Mac for the market collapse has been thoroughly discredited (as I pointed out here, here, and here) the Republican Report says nothing about the evidence that debunks their points. Worse, there was no mention of the unspeakable words noted above in the Republican Report - no "shadow banking" system ... no references to "deregulation" (which Bill Thomas voted to approve numerous times when he was a member of Congress) ... and there were definitely no references to Wall Street's stupidity and greed.

Everything was the government's fault. End of story.

As for final words of wisdom the Republican Report provides us with this classic ending: "We caution our nation's leaders to learn the appropriate lessons from history and take seriously the need to reduce our federal deficit."

Huh?

No mention of favorable legislation, deregulation, agency capture, irresponsible lenders, speculation run rampant, etc. It simply was the government's fault. Paul Krugman discusses the Wall Street Whitewash here. 

I'm going to post on the simplistic arguments used by the Republican commission members later (which you can also read about in my book) but, for now, let's just say the Republican Report is a cruel joke.

Why the Republican Report is a Joke ...
After the 1929 stock market crash many Americans wanted to know what happened. Just like Americans in 2008 they were understandably angry and wanted answers. So after Franklin D. Roosevelt came to office the Senate banking committee created an investigative commission to look at the causes behind the 1929 market collapse and the Great Depression.

To get answers a former Manhattan Deputy District Attorney with experience in financial crimes, Ferdinand Pecora, was hired as chief counsel.

Born in Sicily, Pecora was a hard nosed, no nonsense, kind of guy who believed in the spirit of the American Dream. He saw corrupt Wall Street "banksters" (a term he coined) as enemies of that dream. While FDR gets credit for saving the system, history will record Pecora as the man who did the grunt work that saved American capitalism. As Mary Bottari put it:

The vigorous Pecora commission interviewed hundreds, including financial magnates, their underlings, brokers and analysts, compiled 12,000 pages of testimony and paved the way for a major financial services overhaul. The 1933 Glass-Steagall Act, the 1934 Securities and Exchange Act and other legislation protected the economy for the next 60 years. When these reforms unraveled in the 1980s and 1990s, the ground was laid for a “boom and bail" economy.

To understand how our "boom and bail' economy" collapsed in 2008 Congress authorized the creation of another commission, The Financial Crisis Inquiry Commission. Unfortunately, today's commission - in spite of the presence of Brooksley Born and Phil Angelides - doesn't seem to have the same cohesion, or sense of urgency that the Pecora Commission had.

As we are seeing today - and as I noted over a year ago - while there are several people on the commission who could perform Pecora-like roles, the commission has been stocked with Wall Street sycophants and partisan ringers. Their goal is not to find answers. Their goal is to stonewall, and keep Wall Street from being regulated, like they were after the Pecora Commission. Former Congressman Bill Thomas, in particular, has a stake in keeping the world from looking at all the deregulation he pushed through and signed off on.

Put another way, Republican commission members are not honest brokers.

Finally, I called the commission and asked if anyone could get back to me to discuss the excluded words, among other topics. I'll be checking my messages tomorrow.

- Mark

UPDATE: One of the joys I get from writing this blog is finding out how many smart people tune in from time to time. I've learned from the authority on Pecora - Michael Perino - that the Wall Street investigation actually started in March 1932 while Herbert Hoover was still President. Perino points out that the invesigation basically went nowhere until Ferdinand Pecora was appointed counsel in January 1933, before FDR assumed office in March. Pecora turned the hearings around that winter just as the banking crisis of 1933 was in full swing. He put on the stand Charles Mitchell, chairman of the National City Bank (today’s Citigroup) and revealed massive wrongdoing at the bank in the run-up to the Great Crash. When FDR took office, Pecora was re-appointed as the committee’s counsel. For more on this check out Perinos book, The Hellhound of Wall Street: How Ferdinand Pecora’s Investigation of the Great Crash Forever Changed American Finance (Penguin Press 2010). I encourage you to buy the book.

IT'S DEJA VU TIME ... IN EUROPE

Back in 2004 Wall Street investment giants Bear Stearns, Lehman Bros., Merrill Lynch, Goldman Sachs, and Morgan Stanley were in trouble. Major losses and big debt was on the horizon, as they were on the hook for trillions of dollars in toxic mortgages and securities.

So Wall Street's biggest banks sent then Goldman Sach's CEO Hank Paulson to the Securities and Exchange Commission (SEC) to work out a deal (it wouldn't be his last).

Paulson wanted to get the SEC to allow the biggest investment banks to borrow more money.

Specifically, he wanted to more than double the amount of debt Wall Street's biggest investment banks could carry on the books. Wall Street's strategy was to borrow and bet invest more in the market, so they could grow their way out of trouble.

After their special exemption was granted, the investment industry's debt limit (net capital rule) was lifted from 12:1 and reached more than 30:1 for several firms by 2008 (and more than 40:1 for Merrill Lynch). We all know what happened in 2008. Wall Street's "let's borrow more to get out of debt" plan was a bust because they were borrowing big so they could bet invest big on market garbage.

Fast forward to the present ...

Remember the €110 billion (Euro) package for Greece, and the €750 billion (Euro) “safety net” for all Euro zone members? The amounts were so large because the European Union (EU) wanted to "shock & awe" market players. They wanted to show the world that the EU knew how to deal with Europe's financial problems ... by borrowing more money.

The EU's financial rescue plan is starting to be exposed for what it really is ... a real mess.

Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives has much to say about how Europe plans to fund it's bailout program. Here are some of the highlights (lowlights?):

* In order to finance EU member countries as needed the EU - through the European Financial Stability Facility (EFSF) - needs to issue debt, which will be backed by EU member states. The major rating agencies have already awarded the fund the highest possible credit rating AAA [didn't this happen before? you know, on Wall Street.].

* The measures are not designed to assist Greece or the other troubled countries. In reality, they are designed to support banks that have lent heavily to them [in plain speak this means the plan is more political than economic].

* If an individual nation-state fails to supply its share of funds it's share will be covered by a surplus “cushion” which requires participating EU countries to guarantee an extra 20% beyond their shares.

* A cash reserve will provide additional support (Greece is not included in the EFSF program because no one believes they can cover their commitment).

Got that? Europe is going to cover it's member countries' debt by issuing more debt.

With the amounts we're talking about, isn't this Wall Street deja vu all over again? Seriously. It doesn't matter that the real goal of propping up the banks (instead of individual countries) is to make sure every one's got some skin in the game. The end result is that Europe is borrowing more to prop up a weak system.

And the system is slowly crumbling because no one really wants to confront the world's financial markets - like we failed to do with Wall Street in 2004 - and  make them pay for their greed and stupidity.

Sigh ...

- Mark

WHY WALL STREET IS TO BLAME

So I'm sitting in the barber's chair and getting my hair cut this morning. The talk turns to what's happening in the markets, and who's to blame. The standard Fox News meme emerged: "It's the fault of everyone who couldn't afford to buy a home."

My, my, where to begin ...

Why Wall Street Is At Fault ...
Let's start with this. The money had to come from somewhere. Fox News and their Republican friends may get political mileage pointing at irresponsible borrowers and Fannie Mae as the problem. But the real issue lies with people in the private sector who were creating and insuring shady mortgage contracts, as I've posted on here and here.

On this front, Wall Street knew what they were doing. Their models told them they would make money on their activities, so they pushed for more mortgages. Ability to pay wasn't really an issue. Creating marketable securities that they could bet on was.

Irresponsible borrowers? No doubt there was a problem. But we have to ask ourselves, Why was Wall Street and their financial mandarins so eager to lend to "irresponsible" borrowers?

The simple answer is that Wall Street's market players were becoming irresponsible lenders. They became irresponsible lenders because they had created a sweet ponzi mortgage scheme, built around a fraudulent insurance system.

In the first part of the scheme, as Nomi Prins outlined, between 2002 and 2008 about $1.4 trillion in subprime mortgages were issued. Out of these mortgages Wall Street created ("derived") about $14 trillion in securitized bets. In part because the underlying contracts were subprime mortgages, Wall Street needed insurance for their bets.

I'm over simplifying, but the second part of the scheme worked something like this.

* I tell you I will provide insurance for your mortgage backed securities.
* You must pay me premiums for my insurance.
* If the market collapses, "tough goat cookies ... we won't pay" (this wasn't actually said).

An illusory sense of security (insurance) plus record profits (for Wall Street) made for a euphoric market mood. So more mortgage contracts were sought, written up, and sold off to security slavery. Wall Street created it's own demand. It didn't matter who the mortgage holders were. As long as they could fog a mirror they were going to get a mortgage contract, which was going to be insured (wink, wink) somewhere down the line.

(At the time no one really knew or cared whether the insurer had the money to pay out claims. There were three reasons for this. First, Wall Street's market models said everything was OK. Second, the insured mortgage contracts were labeled as "derivative" contracts which, at the time, were largely unregulated. Finally, everyone was making lots of money).

Ben Bernanke Feeds the Fire
It was like handing the car keys to a teenager, and then being assured that everything will be fine by their loser friends, who are all carrying bottles of booze out the door as they wave good bye.

And why not? Ben Bernanke (the trusty father of the "loser friends" in this scenario) was confident that "market fundamentals were strong" and that bank regulators were doing the right thing. And, besides, national housing prices don't fall, right? Here's Bernanke making these claims before the market collapsed ...




A Ponzi Insurance Scheme + the sage (albeit, wrong) words of Fed Chair Ben Bernanke  =  a sense of market security.

This market chemistry was so soothing that Wall Street and the financial titans of America actively went out and looked for more home mortgages to issue, bundle up (CDOs), and then insure (CDSs) right up to when the market collapsed. Bonuses, sweet fees, and juicy commissions made this a win-win for everyone involved, but especially Wall Street.

"Don't Blame Me ..." Wall Street's Lack of Accountability
At the end of the day, as I pointed out here, when people stopped paying their debts and mortgages - which once gave value to the market securities that Wall Street created - what should have happened is that those who insured the securities should have paid up. Instead, they blamed irresponsible borrowers for ruining their ponzi-scheme.

Let me be clear here. When people stopped paying the debts and mortgages that made security contracts worth something, the people and institutions who provided the insurance for these contracts should have paid up.

But they didn't have to. The American taxpayer did, and will continue to do so long into the future.

MORAL OF THE STORY: Don't count your chickens before they hatch.

MORAL OF THE STORY, II: But especially don't blame Main Street for your own stupidity and greed when you create and feed a mortgage and insurance ponzi-scheme that produces profits for you but undermines the integrity of the market.

- Mark

Addendum: Congress held hearings on Fannie Mae and Freddie Mac today. It was covered by C-SPAN. As expected there were Republicans who wanted to direct blame away from Wall Street. So they tried to blame Fannie Mae and Freddie Mac for the market collapse because of how they backed reckless borrowers. Fortunately, Congressman Brad Miller (D-NC) was there to set the record straight.

He reminded Republican committee members that they once praised subprime lending as the type of innovative lending that comes from deregulated or "unfettered" markets, and because of how it contributed to a spike in home ownership. Among the points Congressman Miller brought up included:

1. When Republicans criticized Fannie Mae and Freddie Mac after 2003, they were essentially using the talking points of Fannie and Freddie's unregulated private insurer competitors (AIG, Goldman Sachs, Lehman Bros., Merrill Lynch, etc), who had financial axes to grind.

2. The private insurers were "running rings" around Fannie and Freddie in lending to and insuring affordable - or "subprime" - housing mortgages (which the data makes clear).

3. The Bush administration pressured Fannie and Freddie to purchase and insure the toxic assets of the private insurers (which constitutes a market subsidy).

There's more, but you get the point. While Wall Street is to blame, Congress had a helping hand in making the mess worse than it should have been. Miller's comments, and the complaining that led to Miller's comments, begin at 1:42 and 15 seconds here.

HAPPY MARKET MELTDOWN ANNIVERSARY (eve)

Today is September 14th. It was Sunday two years ago. Oh, and it was also one day before the market began it's collapse, which sent our country into a national tailspin that we're still experiencing.

I rarely blog on Sundays. But on that Sunday I did.

I had been following our slow motion market collapse (which I discussed throughout 2008 here, here, here, here, here, here, here, here, here, here, here, here, here, here ... well, you get the point) and suspected that the impending market collapse that I had been discussing was upon us. So I blogged about what was happening in the market, on a Sunday no less. I haven't blogged that many times on a Sunday since.

Later I discussed the possibility of Golden Parachutes (which turned out to be a serious understatement), how global markets were responding (not well), and other market ugliness, which we're still living with, the following day.

To be sure, I didn't think that the collapse would be so big as to put the U.S. taxpayer on the hook for at least $20 trillion in bailout cash and other market guarantees. But then again, I didn't think our government - especially if Barack Obama reached the White House - would fill up the tank and turn the keys over the people who ran the nation's car into the ditch. But this is exactly what happened.

Today, banks are flush with bailout cash and corporate America is sitting on trillions in cash as a result of government's decision to make them whole. But Main Street sees no end in sight to the effects of Wall Street's greed and stupidity. What we're seeing in the polls is evidence of this ...

I'll have more to say about all of this in the coming weeks. In all cases, Happy Anniversary (eve).

- Mark