HOW THE WORLD (REALLY) WORKS

One of the things that I regret from writing my first book is what I left out. Perhaps the biggest omission was leaving out Friedrich List. Who the hell is Friedrich List you ask? Good question.

In the pantheon of giant thinkers who studied and then tried to explain how our world works in the 19th and 20th centuries Friedrich List (1789-1846) ranks up there with Adam Smith and Karl Marx. We all know that the ideas that drove Adam Smith helped set the groundwork for the liberal revolution(s) that gave us our free market economies (and the American and French revolutions). We also know that Karl Marx's criticisms of market capitalism set the stage for the socialist revolutions of the 20th century.

Artwork from Artonfix.com

Unfortunately the ideas of Adam Smith have been used and abused to such a degree that the U.S. economy is currently dominated by reckless market players who treat the economy like a giant casino. For his part the writings of Marx were used to set up totalitarian states that got virtually everything wrong about incentives and the human condition.

The end result is that while the U.S. economy seems poised to collapse on its own debt and derivative-driven stupidity (again), the Soviet and Chinese experiments with "worker utopias" have been relegated to the dustbins of history.

The problem we have at the beginning of the 21st century is that adherents and zealots on both sides of the Smith-Marx continuum largely ignore key pieces of history and have not given much thought to how the world really works. Instead they blindly believe in misapplied theories of markets and people, as if the human condition is dominated by some kind of rational homo economicus man.

Those who claim some kind of intellectual bond with either Adam Smith or Karl Marx seem to believe that universal rules of profit and material production drive the human condition when this simply is not the case. Incredibly extremists on both sides ironically find common ground with one another because both see a shrinking (or "withering") state as ideal because of how a rational new man emerges to guide society (yes, they are much closer on this then either cares to admit).

I bring all of this up because a discussion on FB I had this morning got me thinking about what I should have mentioned in my first book.

Specifically, I should have been much more forceful explaining that how most people (especially market players) think the world works is not actually how it really works. Simply put, the state creates the conditions under which societies and markets prosper. If we understood this my guess is that we wouldn't be in the position we find ourselves in today: Praying that the Germans will save the day in Europe ... and hoping that Wall Street doesn't fall off an economic cliff (again) and then drag the rest of the world down with yet another "unforeseen" market collapse.

This article - "How the World Works" - from James Fallows goes a long way in explaining why politicians and market players in America are getting things so wrong. As you will see, it's not so much that they don't know as much as they never learned how the world really works.

- Mark

WALL STREET'S DOING IT AGAIN (PART II): Our Daisy Chain of Debt

Last week I wrote in a post that Wall Street was "doing it again." Specifically, in the post I discussed how broker-dealers in the 1960s had "borrowed" assets from client accounts and used them as collateral to secure loans from banks (i.e. repo borrowing). They then used the money to make investments elsewhere, which they (or the firm) pocketed when the gambles paid off. Problems developed, however, because numerous broker-dealer deals failed, which led to over $100 million in losses for their clients.

As you can imagine, investors were furious. Congress acted and we ended up with new regulations through Rule 15c 3-3. To be sure, broker-dealers in the United States still retained the authority to borrow against client accounts. But they would not be able to operate as loosely as they did in the late 1960s (securities accounts were segregated, new net capital rules were implemented, reserve requirements were imposed, etc.). This is precisely why this article by Money Morning's Keith Fitz-Gerald is an eye opener.

In "How Banks Are Using Your Money to Create the Next Crash" Fitz-Gerald makes it clear that market players are not only using client accounts to borrow money and make trades elsewhere, but they're now borrowing and gambling at record levels.

How is this happening, you ask? Check it out.

Let's say you have a portfolio valued at $5,000. Most of what you have is invested in stocks, securities and other market instruments. Suddenly, you find yourself in need of cash (for whatever reason) and dip into your investment fund. You borrow $2,000 against your $5,000 portfolio. Legally you have to pay the $2,000 back or suffer serious early withdrawal tax penalties. But you're fine with this because you're actually paying yourself back.

Good so far? Great. This is where it starts to get good.

According to SEC Rule 15c3-3, the broker-dealers who run your portfolio can take what you owe to yourself - in this case $2,000 - and use that amount as a source of credit for their own use. Loosely speaking, your broker-dealer can use your promise to repay yourself as if it were a promise to pay the firm. The idea is that since you're going to return the $2,000 to your fund, you're actually paying your broker-dealer because they're the ones who manage the account.

It makes perfect sense, doesn't it? I mean, since you owe your account money, it's actually a credit for the broker-dealers who manage your funds, right?

But wait. It gets better ... for the broker-dealers that is.

According to the rules broker-dealers can add 40% of what you owe to "their" credit accounts. So, for example, if you borrow $2,000 from your account your $2,000 debt magically turns into a $2,800 credit (or borrowing limit) for the broker-dealers. Once your broker-dealer borrows $2,800 and then deposits it in a bank the $2,800 (less reserve requirements) can then be invested or lent out elsewhere. This money can then be deposited, and then used again (again, less reserve requirements), then deposited and lent again, then ... well, you get the point.

This daisy chain of debt is one of the primary reasons that the size and volume traded in our financial markets has exploded (computers, deregulation, etc. have also contributed to its growth).

In effect, your debt contract enables broker-dealers to borrow and gamble in other areas that they might never had done, were it not for your account. And while it's been going on since the 1960s, it really exploded with computers, deregulation, and the creation of new security products (repo borrowing surged past $1 trillion before the 2008 market collapse).

The explosion in financial trading has been phenomenal. Consider the following.

While our national economy produced approximately $14 trillion in goods and services in 2011, the total value (i.e. "notional value") that our financial market players have gambled on various market instruments, or now claim some kind of control over, has grown to well over $300 trillion (commercial banks contribute about $120 trillion to this amount).

To put this in perspective, this is akin to your debt-laden neighbor making $60,000 a year and your bank allowing him borrow $1.2 million to invest gamble as they want.Try asking your bank if they'll let you borrow 20 times the value of your assets & income.

But wait. It gets even better. On a global level, if we throw in what market players in the G-10 nations are doing, the total value (i.e. notional value) that our market players now control or claim some kind of authority over now hovers around $600 trillion, or 40 times what America produces in a year. Nice.

At the end of the day, this financial daisy chain is built on your hard work. It derives it's entire value from your financial accounts (and your debt). But here's the kicker. Whatever paper trail of wealth that's created won't be shared with you (have you ever seen a note in your monthly portfolio statement that reads "Here's an extra $20,000, which represents a small part that I earned from using your account to make bets elsewhere"? Neither have I).

According to Larry Fitz-Gerald, not only is this wealth extracting daisy chain legal, but "it's common practice specified in the fine print of most brokerage agreements." And it's called rehypothecation.

I think I'll leave it that for now.

- Mark

ADDENDUM: All of this is only the beginning. The legal use of your account (i.e. rehypothecation) has created a murky world where activities derived from your account (i.e. pledged collateral rights tied to rehypothecated instruments) can be used by several entities at once (p. 9). This is one of the reasons that the size of our shadow banking system (which is largely unregulated) now reaches into the multiples of trillions (p. 9), while the size of our real economy pales in comparison to our symbolic economy by a ratio of at least 20: 1. 

WEALTH EXTRACTION 101

Remember this? (full view here; thanks Seven)

This chart explains who owns the title to one home in America. It was put together by a securities analyst who wanted to know who held the title to his home. It took him one year to figure this out. Here's the incredible part. It's the day job of this analyst to figure this stuff out on a daily basis.

Yeah, I know. Property rights in America shouldn't be this difficult. What a mess.

Anyways, I wrote about this and the legal maze that makes our financial and real estate markets such a mess earlier (here and here). Specifically I wrote that the very notion of property rights in America may be in trouble because of how Wall Street wanted access to income streams (to create securities), but didn't want to actually produce anything for the money. So they found a way to dump the actual title (plus the administrative and legal responsibility) of a home on to an obscure mega corporate entity called Mortgage Electronic Registration Systems (MERs). Then - in a demonstration of wealth extraction at its finest - they siphoned off the house payments into another legal maze (of securities) that benefited a few Wall Street market players.

And just like that, a small group of market players were able to make claims on millions of mortgage payments (through various "security" instruments) without having any responsibility for filing, registering, and tracking who owned the note on the house. (If you're looking for a metaphor it's kind of like handing the car keys, your wallet, and a keg of beer to your unemployed cousin and telling him to have fun.)

This is where it gets real good.

Rather than deal with homeowners after the mortgage bubble collapsed - and after their mortgage payment-security scheme went bust - Wall Street and other big market players said: "We can't negotiate with homeowners because we don't have the title to the home (MERs does). And besides, the loans have already been sold several times over ... oops."

Then, while threatening that system collapse was imminent if they didn't get bailed out, Wall Street and America's biggest financial players got the federal government to provide them with trillions in taxpayer backed guarantees. Why should big banks and Wall Street have to negotiate with homeowners (and learn from market justice) when Uncle Sam can foot the bill for their greed and arrogance?

Trillions of dollars in bailout money are now being used to purify and prop up an entire industry, while filling financial holes created when the income stream (i.e. mortgage payments) behind Wall Street's (pyramid) security schemes dried up.

Again, wealth extraction at its finest (if you're wondering why Wall Street isn't in jail, me too).

Anyways, I'm writing about all of this (again) because of how this Harper's Magazine article on MERs (hat tip to Barry Ritholtz) explains how Wall Street can make claims on money without actually producing anything of value. It also helps us all understand how our nation's biggest market players have undermined our nation's market integrity, while making a mockery of property rights in America.

If you care about the Constitution (hello, Tea Party) and the future of our nation this is one of the areas where you should be directing your attention.

- Mark

TRAILER PARK ECONOMICS

So, I'm thinking, How do I make this somewhat complicated post easier to understand? In the post I explained how Wall Street and the nation's biggest banks profited after making stupid business decisions. Specifically, I wrote how Wall Street was able to get the federal government American taxpayer to underwrite their stupidity with government taxpayer backed loans after they lost a bundle gambling on reckless derivative investments, and then wrecked the economy. Here's a short - and a bit more humorous - take on the events surrounding our market collapse and bailout.

* * * * * * * * * * * * * * * * * * * *

Imagine that you owned a trailer park development project and went to Las Vegas. You borrowed against your assets and then gambled away all your money. You now have to file for bankruptcy. This is how market justice is supposed to work.

Then, out of the blue, your bank covers your losses in Las Vegas. Then they open the loan spigot for you. The bank also tells you that you can continue doing what you were doing before you lost everything (in this case gambling). Seeing all this the Vegas casinos jump in and say, "Come to our gambling dens (again) ... we're even going to comp your suites." 

The best part (for you) is that the banks are going to charge you virtually zero percent on the money they're lending you. All you have to do is give the bank title to your "trailers with a view" development project as collateral. 

But wait. It gets even better. The banks are going to loan you money based on the value of your trailer park development BEFORE the market crashed. It doesn't matter that you over inflated the value of your $100,000 project by $1 million. You still get your million dollar loan because neat accounting tricks make the value of your crappy assets look good. You can walk away with the borrowed money any time too.

At the end of the day, you know you're going to walk away because the American taxpayer banks are going to be left with your trailer park assets. Sweet (for you).

Incredibly, things get even better for you because, with new money to backstop your stupidity, you can now start kicking out renters that you never liked. With your trailer park investment project effectively paid off, you can become arrogant and vindictive. And you're bringing a new landlord.

Can you imagine this happening? Of course not. This level of reckless support only happens if you're one of the big financial players making stupid bets in America.

While I've oversimplified all of this, conceptually the logic applies. Our financial mandarins, who like to think they're rugged individualsts, are really wards of the state. And you and I get to pay for it all.

- Mark

INTEGRITY OF THE MARKET IN TROUBLE

Those of you who have read my book, or who read this blog regularly, will understand the following two pieces instantly ...

In my book I discuss the difference between wealth creation and wealth extraction. This article from NY Times' columnist Paul Krugman (hat tip to Brian) helps explain the mechanics behind wealth extraction ...

This SF Chronicle article from Robert Reich - which discusses Wall Street's dependence on bailouts, and their subsequent government escorted record profits - helps explain why Wall Street is its own worst enemy.

Both pieces help us understand why the moral justification of capitalism is in trouble. In a few words, Wall Street is destroying what most of us understand to be the integrity of the market.

- Mark

WALL STREET'S GET OUT OF JAIL FREE CARD ... "INTENT"

If you ever wanted to know why no one from the financial sector and Wall Street is behind bars look no further than this 60 Minutes piece on mortgage fraud and Countrywide. Simply put, committing fraud isn't enough to get you prosecuted. You have to show that fraud was also intended (can you imagine a criminal defendant saying, "I didn't mean to kill him, he just happened to be in the way of my bullets"?).

Also, in the FYI category, none of this was confined simply to Countrywide either. It was prevalent and encouraged throughout the industry (and by Wall Street), and is indicative of corporate entitlements and protections that you and I don't get.

I've said it before, and I'll say it again, we can fix a lot of this if we understood Bill Black's "control fraud" better, and used RICO statutes to go after our financial institutions as criminal enterprises ...

- 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

BILL O'REILLY: THIS WEEKS VILLAGE IDIOT

While defending Wall Street and the big banks, Fox's Bill O'Reilly asked why there haven't been any investigations into Wall Street criminality if what they did was so bad. In an exchange with Cornell West and Tavis Smiley, O'Reilly argued that there is "no evidence" of wrongdoing because "they didn't violate any laws!"

What an idiot.

We haven't had big investigations - let alone convictions - after the 2008 market collapse because we dumped trillions in taxpayer funded bailouts and other guarantees into the financial sector. In the process we effectively removed the threat of receivership, bankruptcy, disgrace, or the full force of our legal system from Wall Street's horizon. This is the way our legal and political system works for white collar executives with money.

So, it's not that there wasn't illegality and theft in the lead up to 2008. It's just that the rules of the game prevents our financial mandarins from having to account for their actions. And, yes, this undermines the integrity of our market system.

Specifically, O'Reilly needs to take a look at:


Purified Toxic Crap ...
Bailouts essentially turned straw into gold by using taxpayer funded cash, to purchase toxic "legacy assets" for example. To date, well over $5 trillion in watered stock, bad assets, and toxic securities have been pretty much cleaned up (forcibly) by the U.S. government taxpayer. If the worst is cleaned up, what do you go after?

Information Blackouts ...
One of the cornerstones of any market economy - and any democracy - is transparency. Without it you can't get good information. Guess what? Bailout payout information was deliberately withheld from the public on orders from current Secretary of Treasury Tim Geithner. With an information blackout the most toxic and ethically challenged market instruments have been able to fly under the radar (and then get cleaned up).

Out of Court Legal Settlements ...
Instead of entering into court battles - which are critical for building precedent and case law - financial firms like Goldman Sachs routinely pay fines into the hundreds of millions of dollars. This is chump change when you look at the trillions the financial industry has hauled in (and the trillions more we're on the hook for). It's hard to get convictions when you can pay a taxpayer subsidized fine and walk away.

Right to Sue is Waived ...
At the center of all the toxic payouts in 2008 was A.I.G. In exchange for getting bailout cash, A.I.G. was forced to give up it's right to sue Wall Street firms in court. In a few words, A.I.G. was given an offer they couldn't refuse: Take the money and shut up, or you don't get any help at all (and you might even get caught up in a legal dragnet too). But it gets better (or is that worse?). At one point during the height of the market crisis in 2008 the Federal Reserve demanded unusual national security procedures before it would share or supply critical A.I.G. bailout related documents.

For whatever reason, none of this adds up for Bill O'Reilly.

So, to simplify, you can't be sued or convicted if the problem is purified with a pile of taxpayer backed cash ... information is deliberately withheld or distorted ... you pay record fines to avoid court trials ... and if the initial keystone bailout institution is told they can't sue as a condition for receiving taxpayer money.

Let me repeat the point. You can't get investigations - let alone sued - if the state intervenes to help you bury the financial bodies. It's that simple.

If you understand this you know why Bill O'Reilly is this weeks Village Idiot.

- Mark

Addendum: As you can imagine, things haven't gotten any better over the years. Corporate America is busy playing Blame Games, and are suing one another for selling toxic crap to one another. Similarly, we're learning about the usual political stonewalling and massive lobbying of state attorney generals, which prevents or undermines larger investigations. All of this is critical for understanding why there haven't been any investigations because of how the FBI acknowledged that "mortgage fraud was substantial" as early as January 2008.

UPDATE: Here's Robert Reich with more examples of Wall Street seeking and getting legislative and legal cover from Washington.

THIS SHOULDN'T BE A SURPRISE TO ANYONE (but I'm sure it is)

Bank of America is being accused of cooking the books to hide potential losses of at least $10 billion. Yawn ...

If you've followed this blog, and read about Bank of America's faux paybacks ... or the wonderful world of book cooking Structured Investment Vehicles here and here ... or corporate America's evolving legal blame game ... Bank of America hiding $10 billion in losses shouldn't be a surprise to anyone. But I'm sure it is.

The only question now is how they explain and then bury the problem with some more creative book keeping.

And you wonder why market-to-market is so important for the banks ...

- 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 ...

______________________________________

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).

______________________________________

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

STEVE JOBS ON ENTREPRENEURIALISM

The retirement of Apple CEO Steve Jobs is a pretty big deal. His presentation to the Cupertino City Council on Apple's proposed new campus not only gives us insight into how he thinks about the environment that he lives and works in, but also into how his life experiences as a kid tie into his sense of community. The fact that he showed up personally to make the presentation on the new spaceship campus (it's impressive) says much.

Some of his comments over his lifetime also help us understand markets in the 21st century in ways that Washington doesn't seem to grasp.


Jobs on innovation and creativity: "Innovation has nothing to do with how many R&D dollars you have. When Apple came up with the Mac, IBM was spending at least 100 times more on R&D. It's not about money. It's about the people you have, how you're led, and how much you get it." 

Implication: Real entrepreneurs don't sit around waiting for money dumps or a cut in the capital gains tax to become successful.

Jobs on competition after Microsoft invested $150 million in Apple to help bail it out in 1997: "... time has come to disabuse the notion that for Microsoft to succeed, Apple must fail."

Implication: While being the biggest on the block may be good, competition is a good thing. Monopolies should not be encouraged or pursued.

Jobs on getting fired: "I didn't see it then, but it turned out that getting fired from Apple was the best thing that could have ever happened to me. The heaviness of being successful was replaced by the lightness of being a beginner again, less sure about everything. It freed me to enter one of the most creative periods of my life."

Implication: If Jobs became a better business person after being fired from the company he built we could have gained much by forcing concessions and layoffs on Wall Street after 2008. The industry and the economy would have been better off if we had put a few more companies in receivership, or just let them burn.

Click for super huge graphic.

- Mark

WALL STREET... "SCREW THE CAR FAX"

One of the reasons the market collapsed in 2008 is because market players either ignored or didn't have enough information about derivative market exposure. Then they ignored the casino economy this ill-informed derivative market helped create. This is important because when market players learn new things about co-signers, collateral, job status, price, or market valuations they might be more (or less) willing to consummate the deal.

Think about an esteemed uncle who promises to co-sign a house note for you, and then learning that he is going to declare bankruptcy. But his books still look good, so he's willing to hold off until you get the house. Is withholding this information a good idea, for anyone? Now imagine this market wide.

Not securing and sharing critical information proved devastating in 2008. Even though Wall Street and other market players were backed up by rosy market models (that few understood), the money people on Wall Street started to panic when they learned that big financial houses (like Lehman Bros.) didn't actually have the money to back up their over sized market bets.

Well, hold on to your hats. Because of Wall Street's muscle in Washington, it looks like much hasn't changed after all. Wall Street's lobbyists have fixed things so that we're poised to party like it's 2008. Cue to Prince ...

Seriously, International Finance Review is reporting that the trading centers ("trade repositories") that are supposed to document and house information crucial for derivative markets may not be collecting the information that they should. According to a recent report on Over The Counter (OTC) derivative data, the regulatory scope of derivative trade centers appears to exclude,

"... information contained in derivatives master agreements and credit support annexes, as well as data relating to collateral or payment transfers, or valuation data coming from external sources."

Translated this means that critical due diligence - like collateral and market valuation, among others - that could help assess risk, isn't always documented or presented. You know, kind of like before the market collapsed in 2008.

So, in spite of Dodd-Frank (as I pointed out here), Wall Street can enter into a derivative agreement and they don't necessarily have to reveal previous prices (how much the last customer paid) or demonstrate proper collateral. It's kind of like going car shopping and asking for the Car Fax and being told, "Our market doesn't really require this."

Why is this important? Because as of January 2010 the notional value of the OTC derivative market has apparently grown to about $300 trillion dollars in the U.S., and over $600 trillion between the G-10 countries. This is about 20-40 times the size of the American economy.

So, yeah, we're doing it all over again.

- Mark

MORE CORPORATE BLAME GAMES

About eight months ago - in "Corporate America's Blame Game" - I discussed how our financial services sector is busy suing each other because no one wants to accept responsibility, for anything. Well, guess what? The finger pointing in corporate America continues.

First up, we're learning that Deutsche Bank has shoved at least a billion dollars in toxic loans on to the books of the U.S. government, in the process shifting responsibility and blame on to the government for bad loans that they originated (their argument works like this, "If the government insured it, it's their fault").

Then we hear about our taxpayer bailed out banks illegally evicting military families from their homes, in the process claiming that they were both a "painful aberration" and an oversight in bank practices - ignoring how the industry created the "aberration" environment by deliberately overworking and taking shortcuts on hiring people to properly assess troubled borrowers' home loans (earning $20 billion in savings in the process).

Now we see the banks raking in billions of dollars acting as bad neighbors and slumlords because of their claim that they aren't legally responsible for maintaining their properties, in the process shoving the responsibility on to hard-to-prosecute servicers of their loans.

Making matters worse, is that all of these taxpayer bailed out parasites are hiding behind lobbyist-driven negotiations, and taxpayer funded legal infrastructures to avoid responsibility for their questionable activities.

At the end of the day we end up with one simple truth: The banks are not responsible for anything.

And the big banks wonder why America has lost faith in corporate America and in the financial services sector (only 25% of Americans trust the banks to do the right thing, a drop of 46% points).

Simply put, the banks are demonstrating that they have no sense of responsibility, shame, or irony.

They just have our money.

- Mark

WHY MARKET PLAYERS WON'T INVEST

This should blow the cover off of the "mystical" and unknown forces that many people believe shape and create market behavior. But it won't. People will still believe in the free market fairy tale.

As many of you know, I receive and read through financial reports from various investment houses. Some of them are good. Others (most) are simply garbage designed to get you to spend your money with them. In this Money Morning piece we're told that we should begin to worry about last week's stock market sell off because market players (they're not investors) are concerned that the long string of money the American taxpayer government has dumped into the economy may be coming to an end. Ergo, market players may need to jump in with their own cash if they want to keep the "bull run" in the market going.

Huh?

This is like saying you're going to have to walk up the stairs if the escalator stops working. In market speak, what the writer of the Money Morning piece is referring to are the pampered and bailed out market players (many work on Wall Street) who depend on our taxpayer-funded gravy train to prosper, and now operate like this ...

Now that's a stairway to heaven.

Seriously. For the better part of three decades today's market participants have depended on the American taxpayer federal government to take them to the top of the market with a series of escalator-like subsidies, bailouts, and favorable legislation. They're no longer interested in taking real market risks because they know they can wait for the American taxpayer federal government to keep their bonus and profit gravy train going.

But wait, it gets better. I was particularly "impressed" with these two nuggets of market wisdom from the Money Morning piece:

1. What rescued the market last August was the American taxpayer Federal Reserve dumping hundreds of billions into the market (once again).

2. Strong markets with viable enterprises create self-sustaining economies.

So, let me get this straight ... "Markets driven by fundamentals take longer to develop and are more self-sustaining, while markets driven by liquidity have a lot of trouble once government support is pulled." Why ... this observation is ... it's ... pure genius I tell you, pure genius. 

Now, where have I seen this kind of earth shattering, out of the box, thinking before? Oh, yeah. It was here ...




At the end of the day, the kind of market behavior we're really talking about here is what many of us have known about for a long time. It's called herd behavior. And it's driven by psychological factors that used to be shaped by a system of punishment and reward, better known as bankruptcy or profit. Today these psychological factors are shaped by government supports and bailouts - and NOT by some kind of "mystical' market forces that only Wall Street and the economic talking heads can determine from their crystal balls.

This helps explain why, since they got their guaranteed trillions, Wall Street  isn't very much interested in taking risks, or investing in the American taxpayer who bailed them out. They don't have to in order to get their money.

On the bright side, at least the article acknowledges that our economy doesn't operate according to free market principles, sort of ...

- Mark