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

WHY JP MORGAN'S BILLION DOLLAR DERIVATIVE DEBACLE MATTERS

A few years back officials from Goldman Sachs and JP Morgan Chase went in front of Congress to defend the practice of  betting trading for and against complex investment products that are also known as derivatives. Their argument was that derivatives allowed them to hedge their trades, which is critical for "risk management." This is what "sophisticated investors" and "smart money" do we were told.

What they were really defending was the practice of trading in artificial markets that produce little - if any - economic value.

Conceptually what Goldman and JP Morgan want everyone to believe is that they were doing little more than what the country farmer does. You know, the guy who hedges his bets when he plants corn just in case the wheat crop doesn't produce. Instead Goldman and Morgan executives sounded like a bunch of hucksters peddling toxic crap from the back of a showman's wagon.

Are they really con men? In my view, yes. In the aggregate their efforts at "risk management" in derivative markets amounts to little more than financial snake oil.

Con men or not it really didn't matter what they said in the hearings because many members of Congress are financial and economic illiterates (don't believe me ... check this out). Many only understand economic concepts if they fit on a bumper sticker.

What Goldman and Morgan executives were really trying to do was defend the practice of selling their clients certain products - some of which were designed to fail - with the idea that they could get another client to bet against it. For JP Morgan and Goldman Sachs it didn't matter who won the bet because they collect fees on both ends.

And they they certainly didn't have to worry about the derivative products once they dumped them on others either. They could always hide behind the market refrain caveat emptor ... you know, buyer beware.

Because many members of Congress are financial illiterates - who do the bidding of Wall Street - the executives of both firms gave testimony and left Washington with only a public slap on the hand. Business as usual would be the result. Bonuses were paid out. Mergers continued.

Not surprisingly, after appearing in front of Congress JP Morgan paid a $153 million fine to the SEC for misleading investors, while Goldman Sachs was caught rigging the game against their clients, and then made big bets with FDIC backed money (though they claim it's their money). But along the way the biggest banks got even bigger ...

And the casino continued.

Why do I bring all of this up (again)? Simple. JP Morgan's recent derivative debacle has them losing 2 ... 5 .... or 8 billion dollars. Nobody knows how much just yet. Even they aren't sure (they claim). JP Morgan would like everyone to believe that it's all an anomaly. They even let go of a few culprits (with the now standard golden parachute for screwing up).

My primary concern is that we have been here before.

Now I could take us back to the S&L debacle, the 1987 scare, the LTCM Fed-orchestrated bailout, or even back to 1929 (or any number of other "unforeseen" market failures). But let's not go there. Instead, let's go back even further to see how the "smart money" did things a really long time ago, and then decide whether what we're seeing today is really an anomaly.

The following is drawn from Chapter 4 of my book The Myth of the Free Market:

In A Short History of Financial Euphoria, John Kenneth Galbraith discusses the famous case of “Tulipomania” in Amsterdam at the beginning of the seventeenth century. What started as simple prestige for those who possessed novel tulip bulbs turned into wild speculation over successive price increases throughout 1636.

Specifically, competition over tulips turned into mania, with single bulbs trading for new carriages and homes, or fetching as much as $25-50,000 each. Demand reached such heights the Amsterdam Stock Exchange developed a futures market for the bulb. This market, as well as the dreams of many speculators, would collapse under the weight of its own nonsense and spectacular avarice.

As sellers demanded their tulip contracts be enforced, they were disappointed when their petitions fell on the deaf ears of the courts. Because the market had little to do with the production of actual goods and services, the courts viewed Tulipomania as little more than a gambling operation. As is the case throughout these histories, panic, default, and bankruptcy followed. Galbraith wrote “no one knows for what reason” the speculation and mania ended, but there’s little doubt common sense finally prevailed in a market spun out of control by deluded buyers and sellers.

Now replace "Tulips" in the story with "derivatives" and ask yourself how much has really changed since 1636. With at least a hundred trillion in derivative bets (or more) placed by Americas biggest banks we need to think about what this means for our nation today. Like our Tulip-crazed market players above, many of today's biggest market gamblers are simply interested in extracting wealth from artificial markets.

Oh, look at the pretty flowers ...

Anyways, we need to remember that at the hearings Goldman Sachs' executives sat in front of Congress and brazenly dodged questions as to whether it's their responsibility to "act in the best interest of their clients" (FF to 25:30 in this clip). What this suggests is that simply making money is the dominating mind-set of Wall Street — even if it means deliberately burning clients, or creating the conditions for another market meltdown (which they never see happening).

The focus on wealth extraction instead of wealth creation has been widespread in America for some time now. The following from Chapter 10 of my book helps illustrate the point:

Founded by a group of Wall Street hotshots and leading academics with Nobel prizes on their resumés, Long-Term Capital Management (LTCM) was created in the 1990s to search markets for price anomalies in goods that had shown historical relationships. It didn’t matter, for example, why the price of toothpaste was diverging from the price of tooth brushes; the fact that a price divergence existed was all that traders needed to make a move.

But LTCM was not trading in tooth brushes and toothpaste. They were trading in complex financial instruments that, according to their formulas, had price relationships that rarely diverged. Because the price anomaly in each “product” that they tracked was small, LTCM had to spend big to make money.

After securing hundreds of millions from investors, no doubt impressed with their pedigreed analysts, LTCM still had to borrow big to make their wagers pay off. At its height, LTCM was highly leveraged and owed investors and banks billions of dollars ...

In many ways, LTCM had fallen into the same trap as the purchasers of tulips. The company was comprised of speculators who wanted to make a quick buck. As Martin Mayer put it: "The work done at LTCM, while not illegal or sinful, was totally without redeeming social value. This is not 'investing'; it enables the production of no goods or useful services. It is betting."

LTCM came crashing down in 1998 after Russia defaulted on loans, an event that neither LTCM’s computer models nor it's Nobel laureates in economics anticipated ... The company owed so much money to the banks that the Federal Reserve of New York stepped in and brought the banks to LTCM. The Federal Reserve wanted to make sure that LTCM didn’t suddenly dump their assets to pay the banks.

The Federal Reserve feared that if LTCM was forced to sell its assets they would depress markets by forcing losses on others. The Federal Reserve’s then new chairman, Alan Greenspan, even went so far as to testify that an LTCM “fire sale” could have ended prosperity in our time. The Federal Reserve had to intervene to — in what has become by now a standard refrain — “save the system.”

At the end of the day, if you are betting on the price direction of tulips (the Dutch) ... or betting on the price direction of market anomalies (LTCM) ... or betting on the price direction of derivative products (Wall Street / JP Morgan Chase) one thing is clear. You are not investing (or even hedging). You are gambling.

These guys shouldn't be on Wall Street. They should be on the Vegas strip ... far away from taxpayer funded bailouts.

- Mark

ADDENDUM: With the biggest recipients of taxpayer bailout money controlling over 90 percent of the $135 to $592 Trillion derivative market (yes, that's $592 Trillion) we need to ask more questions about the conditions that created the financial holes at JP Morgan Chase, led to the collapse of MF Global Financial, and other slow drip market "aberrations" coming out of Wall Street. This is especially the case when you consider that the global derivatives market - which takes its cue from the United States - has grown to about $1.14 quadrillion (that's 15 zeroes)

With the total U.S economy producing about $15 trillion in goods and services in 2011 this should be cause for concern.

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.

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

DEUSTCHE BANK ... THE TRUE FACE OF BIG BANKS IN AMERICA?

Most of you have heard of Deustche Bank. Some of you might even bank with them. A regional Deustche branch in Atlanta requested the eviction of Vita Lee, a 103-year-old Atlanta woman, and her 83-year-old daughter. They have lived in the home for 53 years. The good news is that when the movers and county sheriff arrived they took one look at the bed ridden 103-year-old and had a change of heart.


No doubt - in spite of the movers and sheriff being the good guys here - Deustche Bank will try to spin the event so that they look like they're merciful bankers. Then they'll probably try the eviction again, when no one's looking. But, in reality, whatever reprieve is granted to Vita Lee, the merciful banking face we're looking at resembles the one in this scene ...

For those of you who aren't familiar with Deutsche Bank know this: Deutsche Bank was a big trader bettor in the toxic market instruments that Wall Street gambled on during the U.S. mortgage bubble.

Indeed, a Senate report about Wall Street and the financial crisis found that Deutsche Bank even continued to churn out toxic crap even as the market was collapsing, with one top trader betting that home mortgages (which were inside the larger toxic instruments, or CDOs) would fail. Put more simply, Deutsche Bank set themselves up to make money when they foreclosed on certain mortgages. This helps explain why selling faulty mortgages and then kicking a 103-year-old out of her house makes good business sense for Deutsche Bank. They make money off the process.

And, yes, apart from lying to customers in the U.S. and Germany about the investments, Deustche Bank received over $12 billion in bailout funds, and was poised to take a hit of hundreds of billions if the U.S. government didn't bailout A.I.G. (kind of like the House in Vegas covering your losses into the hundreds of thousands, but allowing you to keep your winning bets).

Oh, and for good measure, the former chief economist at the International Monetary Fund called the CEO of Deustche Banks, Josef Ackermann, “one of the most dangerous bankers in the world” because of his reckless business practices.

- Mark

IT'S DEJA VU ALL OVER AGAIN

It's déjà vu all over again ... yet, all the U.S. media want to talk about are Herman Cain's girlfriends, while ignoring the GOPs "Just Say No" obstructionism in Congress. Today, with the debt crisis in Europe flaring up again (this time with Italy), we're reminded that there's another world out there that warrants some serious discussion. Yet, America's political burlesque show is mesmerized (again) by sex scandals, and appears more than content pondering why Mitt Romney hasn't caught fire with the GOP (like that's some kind of mystery). Sigh ...

All of this kind of reminds me of all the Gary Condit sightings, and the shark fear mongering off the Florida coast right before 9/11. Seriously, what's happening with Europe's debt-to-default dance is pretty big stuff, and deserves more attention than Herman Cain's predations. Consider the following ...

Here's a statistical table with more countries that could be affected once the financial dominoes begin to collapse in Europe ...

I know, I know. Simply putting figures like these up without context is unfair.

So consider this. When Germany finally defaulted on it's World War I debt obligations after 1929 it had a debt-to-GDP ratio that stood at around 90 percent (they owed about $33 billion, or about $402 billion today, which was a reduction from the original $63 billion, or about $768 billion today). Today Greece's debt-to-GDP ratio stands at 157.7 percent, while Italy is around 120 percent. Is history whispering in our ear, again? I think so.

Relatedly, when Germany finally defaulted the French Chasseurs Alins (elite mountain infantry) had already occupied Germany's Buer (in North Rhine-Westphalia) region in 1923.

Today, instead of sending in the troops to deal with troubled debtors the world's economic mandarins are banking on central bank (or IMF sanctioned) cash. Specifically, they're banking on the Federal Reserve shoving half a trillion dollars or more on to Europe's books (and hoping no one notices). When all is said they're doing little more than pushing the economic debt can down the road.

This is especially not good when you consider that MF Global's recent Chapter 11 bankruptcy was not supposed to happen. Think about it. In our post 2008 market collapse environment, a firm like MF Global wasn't supposed to be able to borrow so heavily (or use investor funds) to make multi-billion bets on European debt. How much did MF Global borrow? It appears that MS Global may have had a 40:1 debt to equity ratio. What does this mean? It means that if you made $40,000 per year at your job, the bank would give you a $1.6 million loan ... three years after doing the same thing and watching previous clients piss it away gambling.

Yet MF Global's private industry regulator raised no red flags about MF Global debt to equity ratios, nor said anything about it dipping into $600 million of investor money to make their bets.

Yeah, it's déjà vu all over again, on so many levels.

- Mark

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  

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

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

HERE WE GO AGAIN ... BANKING ON DEATH, III

In my book I wrote about dead peasant insurance. It worked something like this. Companies would take out insurance policies on their employees. Those on the lowest rung of the totem pole would be offered a $10-25,000 insurance policy when they were hired. When they died their family would collect the money.

This is where it gets interesting.

What the companies didn't tell their employees is that when they took out policies the policies actually paid out anywhere from $100-300,000, and some times more. But the family members still only received $10-25,000. The companies could do this because of favorable legislation that gave them tax credits (as a business expense) to purchase the insurance policies.

This means that the American taxpayer you and me actually paid for the insurance policies. But the company collected when the "dead peasant" insurance policy paid off.

Nice, huh?

Anyways, we're now seeing the evolution of another death based financial contract. It turns out that Goldman Sachs and the usual suspects on Wall Street want to peddle insurance contracts to pension "investors."

Sound good so far? Not really. Here's why.

Because people are living longer, each additional year of life expectancy adds as much as 4% to future pension requirements. This cuts into profits. Longevity cuts into the bottom line. However, by providing insurance to pensions and other retirement institutions Goldman Sachs hopes to convince the pension groups that they are dumping the expense of each additional life year onto insurance providers.

But here's the catch.

The "insurance" providers are not categorized as insurance companies. As a result the pension insurance system isn't regulated like regular (car, home, etc.) insurance companies. These insurance providers don't have to have the reserves on hand to pay out if something really goes wrong (you know, like in 2008).

Instead, these market players are considered as part of our unregulated derivative and/or "swap" market. Call it the "death derivative" market. But, at the end of the day, they don't legally need to have the money to pay out claims. To be sure, they can collect premiums, and can suck the financial life out of their customers. But, like the economic zombies they're sure to become when the going gets rough, they're not legally obligated to give anything back.
 

 
So, instead of selling insurance Goldman Sachs and other banks are really selling "death derivatives" - which are contracts that derive their value from an underlying asset, and can be bought and sold to others with few if any oversight (similar to an earlier class of "death securities" I wrote about over a year ago).  

In plain language what this means is that if the insurance providers collecting premiums today go belly up tomorrow because more people suddenly die, many pensions who think they have insurance will find themselves facing a shortfall, big time.

Goldman Sachs, and their band of snake oil salesmen, are saying "Don't worry ... private market players know what they're doing ... and besides, insurance companies don't go bust." Huh?

Incredibly, these guys have already forgotten and moved past Lehman Bros. and A.I.G. And why not? They got their money.

We should know better. The motive here isn't insurance. It's revenue. These guys need to be regulated. But they won't be.

It's de javu all over again.

- 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

THIS IS YOUR MARKET ON CRACK ...

The good folks over at Zero Hedge have done us a favor and provided a list of 21 graphs and charts from the Financial Crisis Inquiry Commission's report on the 2007-2008 market collapse. Here it is. The graphs make it clear that we're still in a mess. Seriously.

Want to know how much Wall Street has been betting on the real goods and services produced in the market? Check out this chart ...

______________________________________________

Note: In market-speak, the bets made (both for and against) on financial instruments, which are listed under "Gross Market Value," is represented by the "notional amount" (of outstanding derivative positions) ... I know, I know. But that's how Wall Street speaks.   
______________________________________________

As you can see, the bets on financial instruments (and claims on money) almost hit $700 trillion by 2008. How much is that? Our entire economy is forecasted to produce only about $15 trillion worth of tangible goods and services this year!

One thing becomes clear. After 2004, if not sooner, private investors and the market players on Wall Street began smoking some kind of financial crack.

- Mark

REVERSING AMERICA'S DECLINE ... LET'S BEGIN WITH WALL STREET

The decline of the American Empire is occurring as we speak. It is also increasingly anchored to a nation that embraces the financial smoke and mirrors peddled by Wall Street.

But Wall Street isn't really interested in helping the economy - or our nation - manufacture exportable goods like wind, solar, and other Green technologies of the future. Instead, they're focused on "investing" in the production of increasingly useless (and damaging) derivative markets, accounting discounts (see the S&L mess), structured investment vehicles (capital arbitrage), and other "innovative" market instruments that produce quick payouts and bonuses for Wall Street executives.

As a result, the real economy is being held hostage to the quick financial gains that Wall Street can make in what Peter Drucker called the symbolic economy. The problem here is that the practices embraced in the symbolic economy are little more than accounting gimmicks. They not only create a casino mentality, which contributes to market bubbles, but allows Wall Street executives to use creative accounting to extract wealth, as opposed to building it.

Think about it this way, between 2002 and 2008 about $1.4 trillion in subprime mortgages were issued. However, Wall Street then took these simple mortgage contracts, bundled them up into securities, sold them, and then made huge bets on them. In the process they created about $14 trillion in "securitized" bets (e.g. CDOs/CDSs) which dwarfed the actual value of mortgage contracts. In oversimplified terms, it would be the same as if you were able to bet $1.4 million based on the value of your $140,000 house ... even though you hadn't paid off the mortgage!

The absurdity of these bundled market bets was made clear when housing prices began to collapse, like a house of cards ...

If we channel the financial ghost of Joseph Schumpeter it's easier to say that we're no longer living in a world where Wall Street is interested in helping to build monopolies. They just want to play it.

As always, the proof is in the pudding.

Right before the market collapsed in 2008 the financial sector (investment banks, commercial banks, etc.) accounted for 40 percent of corporate profits. After the market collapse (2009) it accounted for about 36%. Much of this figure is due to the fact that the services sector (which includes insurance, finance, etc.) has grown, and now represents more than 50% of our nation's economy, which is up from 30.2% in 1960.

All of this means that the primary characteristics of the market have changed. We no longer produce real durable goods & services that other countries seek. Instead we are the kings of producing empty symbolic goods & "services" that can't compete with the technologies of the future currently being developed in places like China, Brazil, and Asia. This has occurred because our nation's market players have increasingly found it easier to make derivative bets, play with the tax code, game regulatory agencies, cut examiner budgets, and secure favorable legislation from congress so that their market instruments - rather than real investments in durable goods - can prosper.

The rest of America, if we are to read into Wall Street's actions, can eat crack.

Among the many problems that have emerged from our borrow and spend, tax cut, and deregulation orgy over the past thirty years include:

(1) Massive debt loads for our country ($13 trillion and counting).

(2) The GOP's continued embrace of jihad-like tax cuts for the rich policies (necessary for placing financial bets, and to win elections) and deregulation (necessary for looting our nation's wealth).

(3) The financialization of our economy (finding out how to produce CDO-squared derivatives isn't an espionage task other nations will send their spies out to pursue).

(4) A casino like mentality that focuses on extracting wealth for a few rather than creating wealth for the nation.

How do we fix this mess? Among the many solutions I like, which I've commented on before, include:

(1) Reregulating our financial sector (Europe is actually leading the way here).

(2) Creating a consumer protection agency with teeth (let's start by naming Elizabeth Warren to head the agency).

(3) Tax claw backs (to get back some of the ill-gotten gains).

(4) General tax increases on the top 2% of the nation (who actually did little for their increased wealth over the previous 30 years, beyond securing favorable legislation), and

(5) Enacting the Tobin Tax (a small tax on fast-paced, high-frequency trading, which feed a Casino mentality).  

There's more, but I'll leave it at that for now.

Zach Carter has an interesting article that discusses some of the background information necessary for understanding what needs to be done, and how we can scale back our bloated financial sector. It's real simple stuff. Check it out.

- Mark