Saturday, November 1, 2008

An Article Worth Reading

Here is an article that articulates exactly what scares and frustrates me most about the current markets.

“…(J)ust one more egregious example of an ongoing pattern of manipulation that has become so blatant that either the manipulators have become supremely confident of their invulnerability or they are so terrified of impending doom that all pretense of plausible denial has been abandoned.”

I’ve tried to hold off on complaining about the obvious attempts by the Executive Branch of the US Government to prop up stock prices and minimize the magnitude of each leg of the decline, because I didn’t want to come off as a conspiracy wonk. But I am really nervous about where we now stand.

Two days before Bear Stearns went out of business, you had the top regulator in the country SEC Chairman Chris Cox go on TV and tell the world about how “well capitalized” Bear Stearns was. He isn’t supposed to be their cheerleader. He is supposed to be defending the public from their lies. The stock popped up into the $62 range and was ultimately bought out for $10 a share. People lost a lot of money because Cox went on TV and lied.

In July, the US Government changed the rules and made it illegal to short about 1,000 companies. That’s like the dealer telling me that my pair of aces lose to a pair of twos, because he says so. Goldman Sachs rallied $60 (70.6%) in 24 hours. Did you know that Treasury Secretary Paulson was the former CEO of Goldman? Do you think his cheating helped out a few of his buddies? And maybe his own holdings?

The author of the post says what I have been thinking – that the technocrats in Washington are either so cocky that they think they can break the law with impunity, or they are so scared by what they see, that they are breaking all the rules to keep the system from imploding.

So I am very nervous. This will not end well. Either the market will teach the cocky technocrats who is boss, or the markets will prove to be bigger than those trying to save it by manipulating it and will collapse under their own weight.

Price manipulation always ends in crashes as investors lose confidence in they system. I fear that we have unfinished business to do to the downside.

Wednesday, October 29, 2008

It's Fed Day

Every now and then I need to take a step back, look at history and reset my brain. I think it is important right now to review the writings of the Fed Chairman Bernanke. Because what he has written about in the past is having a big impact on the present.

Deflation: Making Sure "It" Doesn't Happen Here

I want to start with the speech that put Ben Bernanke on the map. The first time I read it, I knew that it was a seminal event and I knew that this guy was going to be the next Chairman of the Federal Reserve.

I actually printed copies of this speech, highlighted the important parts and mailed the copies out to clients. I refer back to it often, because it layed out the tools the Fed might use to fight deflation over what I assumed would be the years 2002 - 2016/2018.

Do you even need to ask yourself where we are in history, when the expertise of the Chairman of the Federal Reserve is studying “The Great Depression”?

(Unless otherwise cited, all quotations are lifted directly from this Bernanke speech)

“It” is deflation.
Deflation is far and away the greatest threat to our economy. If you recognize this and learn about what tools policy makers may use to prevent or cure deflation, then you are way ahead of the game at figuring out how to position money.

“Deflation is defined as a general decline in prices, with emphasis on the word ‘general’.”

“Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices, such as the consumer price index, register ongoing declines.”

“Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.”

Why is Deflation Such a Risk?
Deflation is such a risk to the US Economy, because the real value of debt actually increases during periods of deflation. If you owe $100,000 and have a deflation rate of -10%, then the real value of what you owe is $110,000 in year 2! So, by definition, deflation increases the cost of borrowing and of holding debt. Increased borrowing costs decrease economic activity.

When you get an economy with massive debt and you get deflation, what you end up with is what is called a “Deflation Death Spiral”. All this means is that deflation causes the cost of borrowing to increase, which leads to decreased demand, which leads to companies lowering prices to increase sales, which leads to deflation, which leads to the cost of borrowing – lather, rinse, repeat…

So deflation is causes by falling demand and deflation leads to falling demand. In the US Economy, the real cost of borrowing must diminish each year as the value of depreciating asset diminishes. This is done via inflation. In an economy which is designed to use borrowed money to purchase depreciating assets, deflation is incredibly destructive.

“In a period of sufficiently severe deflation, the real cost of borrowing becomes prohibitive. Capital investment, purchases of new homes, and other types of spending decline accordingly, worsening the economic downturn.”

Deflation “impose(s) an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value."

“The financial distress of debtors can, in turn, increase the fragility of the nation's financial system--for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. … massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America's worst encounter with deflation, in the years 1930-33--a period in which (as I mentioned) the U.S. price level fell about 10 percent per year.”

How Do You Fight Deflation
This is the most important part of the speech. Remember, this speech was in November 2002. The tools he discusses were brought up as potential solutions 6 years ago! These guys knew this was coming and have been positioning things in preparation. for the inevitable.

The goal for defeating deflation is to “expand aggregate demand”. This phrase shows up a lot in his writings, so I think it is the key driver for all of Bernanke’s policy decisions. More on this later.

Cut Interest Rates
The Fed’s best tool for controlling demand is increasing or decreasing short term interest rates. They lower rates to increase demand, by making borrowing cheaper. However, sometimes rates get to effectively zero. Right now, the 3-month US Treasury yield is 0.565%. It is effectively zero right now!

The Fed “can no longer use its traditional means (rate cuts) of stimulating aggregate demand”, but it has by no means “run out of ammunition” for fighting deflation.

“When the short-term interest rate hits zero, the central bank can no longer ease policy by lowering its usual interest-rate target.”

Expand Aggregate Demand
“(A) principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition. As I will discuss, a central bank, either alone or in cooperation with other parts of the government, retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is at zero.”

The 2002 Recession and “Preventing Deflation”
“(T)he best way to stay out of trouble is not to get into it in the first place.”

“(W)hen inflation is already low and the fundamentals of the economy suddenly deteriorate, the central bank should act more preemptively and more aggressively than usual in cutting rates (Orphanides and Wieland, 2000; Reifschneider and Williams, 2000; Ahearne et al., 2002). By moving decisively and early, the Fed may be able to prevent the economy from slipping into deflation, with the special problems that entails.”

In 2002, the Fed implemented strategies to prevent deflation. Greenspan cut rates to 1%, thus making money cheap to boost consumption and they removed virtually all regulation from the mortgage industry to make sure that real estate prices increased.

“A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices.”

And thus we had the Bush Tax Cuts.

So deflation was avoided for several years – (Greenspan & Bush)) kick the can down the road, so the next guy (Bernanke & Obama) would have to worry about fixing things.

Curing Deflation
We are now knee deep in price deflation for assets – real estate, stocks, bonds. This has ground the economy to a halt. Moreover, we now have huge systemic risks which were not present in 2002. Look at what Bernanke was saying about the economy in 2002 –

“I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small…”

“A particularly important protective factor in the current environment is the strength of our financial system … our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape.”

Things have clearly changed, as the banking system is now insolvent and the average consumer has too much debt, while the assets they own are losing a lot of value.

What I am concerned about now is what policies will Bernanke use to “Cure Deflation” and how do I defend money and try and make money as these policies are implemented.

The Goal!
The goal of Bernanke is to “expand aggregate demand” at all costs. Carve that like backwards into your forehead so you read it every time you look in the mirror.

Let me explain “expand aggregate demand”. There is a difference between Real and Nominal Demand. Real is what you can buy next year versus this year based on the effects of inflation on your purchasing power. Nominal is the actual price you pay.

So if you bought something for $100 this year and inflation is 10%, then your Real purchasing power next year is effectively 91% of this year, as you have $100, but now must pay the Nominal (Inflation-adjusted) price of $110.

When Bernanke discusses “expand aggregate demand”, what he means is that he wants to make sure that on a Nominal basis, the economy is always growing year over year.

Bernanke gave a speech in the past 6 months (I can’t find it right now) where he defines his goal for the economy. He wants the economy to grow in nominal terms, so that we do not have debt deflation. Here is his math –

In 2008 you sell 10 widgets for $1 each, or a total of $10
In 2009 you sell 1 widget for $11, or a total of $11
You have $100 in debt and need to pay $10 per year in interest.

So by driving prices up 1000%, you are able to make enough money to service your debt. Production is down and inflation in through the roof, but you were able to pay your debts and that is all that seems to matter to Bernanke.

The Printing Press
“… (U)nder a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.”


Print enough money to cause enough inflation to make sure that the Nominal economic output goes up, regardless of how badly Real economic output falls.

“By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

“If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.”

This is pretty sobering stuff, isn’t it?

Buying Assets Outside the Fed’s Mandate
“Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys.”

“Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral.”

How many programs have we seen in the last 12 months to buy assets from banks -

Money Market Investor Funding Facility (MMIFF) $250 billion
Term Auction Facility $476 billion
Commercial Paper Funding Facility $900 billion (not a typo)
Bear Stearns Bailout $30 billion
Freddie Mac Bazooka $100 billion + $25 billion per month
Fannie Mae Bazooka $100 billion + $25 billion per month
AIG Nationalization $85 billion +$35 billion
The Paulson Plan $700 billion

Do you think they are making this up as they go along?

You can check the Fed's balance sheet here -

I think the Fed's Balance Sheet is now at over $4.5 trillion ($2.5 trillion to foreign banks). Did you see where Paulson decided that they would keep this $4.5 trillion off the books of the US Government (can you say Enron and "off balance sheet" accounting).

They know that the year they decide cut the accounting games, they will have to declare the number as a deficit for the year. How would you like to be running for office the year you pass a $2.5 trillion budget with a $4.5 trillion deficit?

Cap Interest Rates
“So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities.”

“Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951. Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade. Moreover, it simultaneously established a ceiling on the twelve-month Treasury certificate of between 7/8% to 1.25% and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill.”

Take a look at the chart of the 30-year US Treasury Yield ($TYX = yield x 10) and you can see how the Fed has artificially held interest rates down in an effort to stimulate demand. At some point this changes and you had better not hold long-term bonds.

Here is a chart of the Price of the 30-year US Treasury. When the cap is lifted off of interest rates, the price of the 30-year bond will get smoked.

Buy Foreign Debt
“The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.”

The US just bought Money Market Instruments for the Korean

The Fed has now injected money into 14 foreign markets and has REPO agreements (at least $450 billion and counting) with Brasil, Mexico, South Korea, Singapore, New Zealand, Japan, Switzerland, England, European Central Bank, Australia, Denmark, Norway, Sweden and Canada. the list grows each day.

Yesterday, the Fed announced the possibility of loaning $25 billion to a Korean Sovreign Wealth Bank...

Fiscal Policy
Outside of the Bush Tax Cuts of a few years ago, the next President will seek some sort of massive new stimulus plan. My guess is that it will be an Alternate Energy/Electric Automobile version of the Kennedy Man on the Moon mandate.

“(I)n lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets.”

Also look for the government to buy a lot of vacant Real Estate to prop up prices.

People wonder why Japan has done things so poorly for the last 20 years. Did you see that the Nikki hit a new 26-year low this week? So EVERYBODY who bought the Nikki since 1982 is DOWN!! Holy cow…

“Japan's economy faces some significant barriers to growth besides deflation, including massive financial problems in the banking and corporate sectors and a large overhang of government debt.”

The US has massive financial problems. We are overleveraged and insolvent.

“Second, and more important, I believe that, when all is said and done, the failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal. Rather, it is a byproduct of a longstanding political debate about how best to address Japan's overall economic problems.”

“(C)omprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy.”

Japan is still in their funk, because they never allowed the bankruptcies to occur and they never let unemployment spike. These are necessary pains in a nasty recession. If you have excess capacity, then you need to close it down – that means close factories and lay off employees.

I think that means we are in for nasty unemployment and a lot of companies going out of business.

My Point
The Fed has been taking action for at least 6 years to fix the current problem we face. I have been out of stocks for a long time, but I’m here to tell you that we are closer to the end than we are to the beginning of the Bear Market. Moreover, the economy is a long way into working through this mess.

I’m actually getting pretty optimistic that things will bottom in 2009. Because I think the policy makers get it. You will probably look back at the 2008-2009 bottom as a Once-In-A-Generation entry point for stocks. We’ll see.

Their goal is to increase spending. That means earnings go up and stocks go up with the.
Their goal is to increase asset prices via the printing of a lot of money. Again, that means asset prices go up.

It also means that inflation goes up and so will interest rates. So bond prices will fall and fall hard.

It’s amazing what you can figure out when you do a little homework…

Sunday, October 26, 2008

Market Review at Multiple Timeframes

I wanted to break the markets into multiple time frames and show you a couple indicators to give you an idea of what I will be looking for when I deploy money for the next 2 to 4 years.

Here is my “Roadmap”. If the markets are above the Red and Blue lines, then I am selling over-extended rallies and buying pullbacks into the Red and Blue lines, because we are by definition then in a Bull Market and I want to be on offense.

If the markets are below the Red and Blue lines, then we are in a Bear Market, I am on defense and I am looking to short rallies into the Red and Blue lines and buy over-extended crashes.

I have been telling anybody who would listen that when price closed a month below the Blue and then Red lines, that it was time to raise cash, because I was afraid that this would be a replay of the 2000 – 2003 Bear Market. Pretty good call, eh?

See those green lines”? That is the bottom of the last Bear Market and the price range is proving to be a magnate, sucking prices down into them. I would be very surprised if price does not go below those levels before this Bear Market is over. I believe this, because it would scare the heck out of the unprepared and induce them to sell at a very bad time.

The bottom of the chart is the “Bullish Percent Index”. This essentially measures the percent of companies in uptrends. Panic bottoms have extremely low readings in this indicator. This is the lowest I have ever seen the indicator. But when it reverses up, it will confirm a rally that may be profitable to own. I will discuss this indicator in detail as a bottom appears to form.

One more thing about his chart – see the Green Circle? That is the bottoming process of the last Bear Market. This Bear Market will also end in a bottoming process. So don’t go jumping out the window if you miss getting fully invested on the first decent bottom. The odds are real high that it will be revisited, and maybe undercut, at least once.

You may be asking yourself why I was so convinced that we would replay the 2000 – 2003 Bear Market. It is because we are now replaying the 1966 – 1982 Secular Bear Market.

See how the market trades in long rallies followed by extended periods of consolidation (violent sideways trading)? The rally phases (Secular Bull Markets) are characterized by increasing multiples and decreasing inflation and interest rates. The consolidation phases (Secular Bear Markets) are characterized by compressing multiples and rising inflation and interest rates.

We are just replaying the 1966 -1982 timeframe. I’m not a rocket scientist. I just study a lot and recognize what the markets have to tell me. The endgame to all of this is really nasty inflation and a huge spike up in interest rates designed to kill that inflation (ala Paul Volcker).

So we are in a Crash leg of a Secular Bear Market. I will do a detailed post tomorrow on potential bottoms for this Crash leg. I am not telling you these numbers will be fulfilled, but if we get down to them I will be on alert for a potential big rally. And this is really all I can do is try and figure out high-probability situations and be on my toes if they materialize.

Now I want to look at the daily action of the New York Stock Exchange ($NYA). This index is a broad representation of what is going for the average stock. On Friday, the $NYA closed below the -35% band (Black Line) for the first time in this plunge (Red Arrow). What I see here is a 13-day consolidation after the plunge of late September and early October. Friday may have been the first day of the next plunge. Or it could be a retest of the October 10 low. We’ll see. The next few days will tell me whether I should be shorting or buying.

I am concerned about the chart – the Volatility Index ($VIX). Call it a fear gauge – the higher the number, the more expensive insurance becomes (Put Options).

What concerns me is that the VIX just broke out (Green Arrow) of a multi-day consolidation (Green Lines). It is bad for stock prices if the VIX has another leg higher. I will be watching this closely.

Here is the Dow Jones since the October 10th bottom. I keep bringing this chart up to show how the markets are being driven intra-day.
The Pink Line is -1 Standard Deviation below the 260 period moving average. See how it has capped trading the last few days, where rally has topped at the Pink Line (Pink Arrows)?
The Purple Line is -1.5 Standard Deviations away. It has served as support for each bought of selling (Purple Arrows).
The Fibonacci Levels (Blue Lines) have also come into play as I mentioned they would last week.
I added the -1.25 Standard Deviation (Black Line) to show how it has been the key pivot for all intra-day trading the last 3 days.

The last few days I have done some short term trades to try and take advantage of massive intraday volatility. I have done this for myself and for a handful of clients.

The majority of my clients are in cash. For long-term allocations, I will be using the Daily, Weekly and Monthly charts to give me areas of potential reversals. Unless you can just sit there and watch things all day long, I would use the longer-term charts and a combination of volatility bands, standard deviations and indicators to determine when to try and enter stocks. I’ll keep you posted.

Updated Derivative Exposure and Bank Consolidation

First, an updated picture of the banks with massive derivative exposure -

The consolidation in the big derivative players continued last week. It should not surprise you how things played out. Here is a recap –

"National City #14 is being bought by PNC Financial #10. The US Government is giving PNC about $9 billion to do the deal. PNC is “selling” $8.9 billion in “preferred stock” to the government. This is just the government paying PNC for the $9 billion loss they will take for “buying” National City. "

"Suntrust #9 is going to “sell” between $2 billion and $4 billion in “preferred stock” to the US Government."

There are now only seven banks yet to merge. On 10/21 I wrote the following about National City (NCC)

“I think NCC will either get nationalized or bought by a larger bank in the not too distant future.”
On 10/21 I wrote the following about PNC Financial

“I think they will be buyers and not sellers. Just a guess, but we'll see.””Remember, they can only by buyers if the Fed gives them big piles of money. So expect these guys to get bailed out. In Fed Speak, it will be a "injection of capital" in the form of the Fed buying preferred stock "at no risk to the taxpayer".”

Here is what I wrote about Suntrust on 10/21 –

“The 2 stragglers are Suntrust (STI) #9 and Northern Trust (NTFS) #11In my opinion, these are coin flips are to whether they are acquirers or acquirees.”

The 10/21 post is here –

You can read more detailed analysis of which banks have exposure to derivatives here –

The Great Baby Boom Unwind

I am asked often about who is to blame and who I am voted for. Believe me, there is enough blame to go around to both political parties. So I won’t even touch that subject. These are just my thoughts and you are free to debate them or prove them wrong. I will not be offended. I know I am often wrong and that is why I use stop losses on all trades…

The Glass-Steagall Act was designed to separate the guys who create capital (via leverage) from the guys who create risk. Because what ends up happening is greed takes over as you realize that the more leverage you create, the more profits you make. So the people who are responsible for managing risk get thrown out of the room, because anything they do to impede risk creation costs the bank money.

The Baby Boom
This all starts with the Baby Boom. 30 years ago, the government started enacting policies to prepare the country for the inevitable costs of the Baby Boomers retiring. The costs would be massive increases in entitlements and a substantial decline in consumption. So the government needed to formulate strategies to mitigate the cost of the retirement of the Baby Boom generation.

Replace diminishing Baby Boom Consumption
One goal was to add enough consumers to make up for the declining consumption of a retiring Baby Boom.

On the home front, they did this by opening up the border. How many illegals have received amnesty from Reagan, Bush, Clinton and Bush? Adding 30 or 40 million new consumers is a lot easier than having 30 to 40 million new kids, or outlawing abortion…

On the international front, they wanted to create millions of new middle class consumers in emerging markets. This was done by turning America into a hyper-consumer for the products made in these countries.

Companies move to countries with cheap labor and build manufacturing facilities (the focus is on China, India and the Philippines). Foreign workers have massive savings rates and their surplus savings is recycled back to us via the purchase of US Government debt (more on this later) as foreign governments buy US Treasuries to finance the debt needed to pay for all this excess consumption.

Diminish Entitlement Costs Via Inflation
This was a tricky play initiated under Clinton (Bush has continued it, so don’t get all politicky on this one).

In 1997, the government changed how inflation was calculated so that it could keep the annual Cost of Living Adjustments (COLA) on benefits artificially low. By definition, this decreases the real cost of entitlement programs versus inflation each year.

COLA is running at about 5% less per year than it should be. Check the chart titled “Alternate CPI Measures” here. Notice how annual difference between the “Pre-Clinton Era CPI” and the “Official CPI” –

Think about what this allows the government to do. It allows them to effectively CUT inflation-adjusted future Social Security benefits, without having to admit it or be forced to vote on it. Sneaky, but needed…

Credit driven asset bubbles were the engine to drive the consumption train.

The first big effort to drive the expansion of the middle class in emerging markets was the Tech Bubble. The Tech Bubble was financed by the government under the pretext of getting everybody prepared for Y2K. Cheap money was provided to companies, leading to lots of unprofitable businesses and massive over-capacity to be created.
In early 2000, the cheap money stopped flowing and you saw a massive implosion in the pricing of all things technology because of all the excess production capacity created during the Tech Boom.
Scores of US Investors got ravaged, but the foundation was laid for the creation of the new Middle Class in the Emerging Markets

Real Estate
As the Tech Bubble was collapsing, the US Government needed to create a new bubble to stave off a Depression (yes I used the “D” word). The goal was to drive up the price of another asset class to full consumption via the “Wealth Effect”. The asset chosen was of course Real Estate.

In order to drive housing prices up, you need to increase demand. You increase demand by lowering the cost of money. You lower the cost of money in the following ways –

Cut Interest Rates
In late 2001 – 2002, Greenspan (appointed by a Republican and also used by a Democrat) gutted interest rates for historically low levels (1%). As rates fall, people refinance and their monthly payments go down.

Lower Lending Standards
You can also increase demand by lowering lending standards. The more people who can buy a house, the higher the prices go, so the US Government decided to allow people to lie on their loan applications and allowed the lenders to take those applications without checking the “facts” presented by the lenders.

Create Exotic New Ways to Finance
Banks started to create such things as 40 and 50-year mortgages. They created mortgages where you didn’t have to pay interest or principal until some future date. They created mortgages where your interest rate was artificially low for a set number of years.

People got greedy and used these new types of mortgages to buy homes they knew they couldn’t afford. Investors hoped that the price of their houses would go up and they could refinance in a few years.

It used to be that when you needed a loan, you would go down to the bank and if they loaned you money, the bank would keep the loan on their books until you paid the loan off. They knew they were taking the risk, so they were smart about how they loaned it out.

Then some smart guy came along and told the banks that they could take the loans they made and lump them all together into a security and that security could be sold to private investors anywhere in the world. The idea would be that you would have “Ratings Agencies” tell you how much risk was in a security, that risk rating would determine the yield the security paid and also determine the interest paid by the initial borrow of the funds.

The Rating Agencies
If these guys do their job, then the system works. Because if you have bad credit, then the interest rate you would get on your loan would be so high, that you couldn’t afford to take the loan. If you have bad credit and don’t take the loan, then the bank doesn’t take on any risk.

But what really happened? The “Rating Agencies” failed to rate based on credit quality and instead got into a practice where they gave virtually ever security the same highest rating of “AAA”. This allowed banks to keep interest rates artificially low and allowed borrowers with bad credit to buy houses they couldn’t afford. There is absolutely no chance that this could occur without the explicit consent of the regulators and the US Government!

Oh, and did I mention that the banks who needed the highest credit rating on the securities they created were the same banks who paid the Rating Agencies to rate their securities? The Rating Agencies are now admitting before Congress that they would have rated dog sh*t AAA if a bank paid them enough money.

This is the Cliff Note version. I could go into a lot more detail, but I’ll spare you the outrage.

Implied Government Guarantee
Here is where all this stuff costs the taxpayers.
Again, foreign governments were the primary buyers of the securitized mortgages. They bought a lot of these issues from Freddie Mac and Fannie Mae. Freddie and Fannie are/were agencies of the US Government, which meant that the securities they backed had the “implied” backing of the US Government. Foreigners understood “implied” to mean “explicit”, just like the securities of Ginnie Mae and TVA have.

You remember the testimony before Congress in July where Paulson wanted the “Bazooka” to help him prevent Freddie and Fannie from failing? Did you know that at the time he was begging Congress for money, he was spending his evenings assuring Asian Central Banks that the securities banked by Freddie and Fannie had the “explicit” backing of the US Government?

Freddie and Fannie back about $4.5 trillion of mortgage debt. The US Taxpayer is now responsible for ALL OF IT!!!!!!!!! We are bailing out the Central Banks of Asia who knew damn well what they were buying. Moreover, the directly benefited not only from buying this crap, but the very creation of this crap, because it fueled the consumption in the US for the products manufactured in places like Japan and China and India…

It just gets better!

Enron, Sarbanes-Oxley and You
You remember how the fall guy for the last bubble was carted off to jail and Congress had their hearings and the Sarbanes-Oxley Act was passed with great fanfare?
Do you remember what Enron did and Arthur Andersen signed off on? They did something called “off balance sheet accounting”. They basically took all of their losses and hid them in off-shore limited partnerships. When the news got out about what they were doing, Enron imploded and Arthur Andersen went under.

Why do I bring this up? Have you ever heard of a SIV? A “Structured Investment Vehicle”. Do you remember Paulson calling for a “Super SIV” earlier this year? A SIV is just an Enronesque off-balance sheet accounting trick used by banks. The Fed allowed banks to take the accounting trickery of Enron to a whole new level. They did so, so that banks could write a lot of bad mortgages and drive housing prices to ridiculously high levels.

Take Citigroup as an example. They have “assets” of $1.327 trillion. Did you know that they have off-balance sheet assets of another $1.2 trillion? Right now, Citigroup has a net worth of $67 billion. They are levered 37.7 to 1! That means the prices of the bonds that they hold only need to fall another 2.65% and Citi is out of business!!

The US Government allowed all this to happen and the taxpayer is now stuck paying the bill.

I’m tired of writing about this stuff. It goes so deep and it is so pervasive that I could write a book about it.

The bottom line is that this game has been going on for decades and the endgame is massive inflation to get rid of the real value of the debt.