Wednesday, December 28, 2011

Around and Around and Around we go

I wrote this as a challenge on one of my favorite venues, Karl Denninger's market ticker.  Karl is right on, but off base, because these are surface issues.  The real issue is how can we fix what is broken?  In short, I describe why the fix won't be done, but will happen anyhow.  

Why do you keep messing with a broken and non-fixable monetary model Karl? They are doing the only thing they can do without allowing it to blow up or blowing it up themselves. Debt has to be taken out of the system. There is over $50 trillion in debt in the US and a monetary base of under $3 trillion. It is the mouse screwing the elephant syndrome.

It isn't just the crap on the balance sheets is mismarked, what is on the other side of the balance sheet doesn't exist without it. The balance sheet is gridlock. Write off the debt, bankrupt the banks, where do the deposits go? Where does the insurance go? Well, the government bails it out? With what? More debt. Writing a check for a bad check that has already been cashed. You can't even spend this stuff. This is not back in the Ghetto financing, where adding and subtracting work. We are talking about what is supposed to equal what doesn't equal. Once in awhile, the call comes in and guys like Corzine are found with their pants down. Need some money? Get some that has already been borrowed 20 times and borrow it again. Then let someone else borrow it and again and again. The hypothecation did that and rehypothecation did it again and again. The money in the accounts had been hypothecated several times when it got there, unbeknownst to the depositor. The assets in the banking system bad? What do you think the deposits rest upon? MF Global over and over, but they never mark to market.

Irving Fishers Debt Deflation Theory was right, but off base. You can't recognize what Fisher wrote as valid if you are going to solve the problem, because the debt and the media that was created with the debt are one and the same. There isn't any fooling with the Federal budget going to fix this problem. At best they are going to pump enough air into it to keep it from collapsing for awhile. Then, someone with enough power is going to ask the system to mark to market. This is why money builds up in Central Banks, as the banks that get the money in the course of business damn sure aren't giving it back to somoene who can't mark their books to market. Bankers aren't stupid and I believe some of them are ecstatic they got what they had out there back in 08 and 09.

You have to remember the game works 2 ways. Not only has the world spent 3 or 4 years income, but someone has put up that much income as well. What isn't in bank capital resides in deposits. In the scheme of things, other than the fact the economies of the world need to produce the return to support this much debt and equity (equity value is also dependent on debt service, otherwise it too is worth scrap at best), what do these figures mean?

The question should be, how do we support this much debt/equity and maintain any kind of growth? This is an important question because the world is organized around a pension system idea. The question should be, if people need to save so much for retirement, how can these assets be accumulated in sufficient amount to produce sufficient life income for retirement. If we liquidate, this is where the money will disappear. It has to. Where else it going to come from? Do we have another skittles crapping unicorn that is going to replace what don't exist?

The Genie is out of the bottle Karl. All these fucks in DC we see on TV, the idiot in the Fed are all merely ants on the log on the Mississippi at flood stage. The ant thinks, my motor must really be running good for me to be driving this log this fast. Watching the stage show in Europe should give people some idea how fucked the system is. One side over there has to realize their retirement is gone if they bail out the other side. It all exists by virtue of the other side, which is the paradox, which is why depressions are so hard to solve and why they result in war. It is kind of like the parasites that ride around with sharks.

I'm working on a piece called The Great Reset. It may be more of talking about the problem, but the problem can't be solved if it isn't understood. What is being talked about in public shows no understanding of the problem. I do believe Bernanke has a clue, my main problem being they didn't clean out the banks before he fired his bullets. You can't solve insolvency when the money going in keeps going out the back door. I must add that a bank making loans with no capital is counterfeiting. All this stuff is mere entries on a balance sheet and a capital account that reads zero must be funded out of what is left on the credit side.

Point being, we don't have a political solution to this. This mess is going to work itself out on its own, whether we struggle with it for 1 year, 3 years or the next 100 years. As long as you are less broke than your next competitor, you are probably safe on a day to day basis. There isn't anyone going to be piling into the Euro any time soon, Japan is a ticking time bomb and the USA is being run by a bunch of idiots that can't agree on anything, including a narcissist Commander in Chief. Funding performance of bad assets won't do anything other than unjustly enrich those that control these assets.

The first thing that government needs to do is end the portions of debt that are out of control. Public pensions that would cost $1 to $3 million to fund need to be recast. There are many websites of insurance companies that have annuity calculators. Go to one and plug in $50,000 a year for a 55 year old female and see what that stream of income costs you. The only way to reduce this is to raise interest rates, but the Fed has little control over longer term interest rates. What percentage of the typical corporate employee population has $1 million? Bet it is a small percentage and I bet few of them were guaranteed to have that much at their disposal. On any account, those won't be paid, at least not in a few years, because they can't be paid.

I think we agree the compound factor can't go on to infinity. It can't be stopped either or it implodes. Paulson was probably sincere when he talked about tanks in the street. The fucker should have thought about that before he and his cronies created the doomsday machine, but they may have been late on the scene. What has transpired over the past 40 years may have been all that could be done to keep the game going. Would it have been easier to have changed course 20 or 30 years ago? Maybe, but look at how rough of shape the world was in back in 1990 after deflating the US for 10 years. Trend deficits for 1990 were over a trillion if you went back to 1975, so the $200 billion to $300 billion weren't that far out of bounds. We made it about 20 years late.

There is going to have to be a haircut and it is going to have to be well thought out. We can't continue to replace the credit entries with more debt, which is what governments are doing. In the capacity of banking, recapitalization can only be done from the credit side of the balance sheet, which means monetary base has to shrink in order to recapitalize or debt has to be maintained. This means the accounts have to be haircut to form the new capital, either voluntarily or through bankruptcy. There needs to be a great reset.

Monday, September 12, 2011

They Have All Been Sucked Dry Part 2

There are a few people out there, like Steve Keen, who appear to have a concept of what has occurred and where we stand as far as debt and the economy go.  I am educated in finance, my degree earned in the 1970's before they took to heart the various financing techniques, that brought us to where we stand.  But, in earning this degree, I also took a number of economics courses, none of which recognized the role debt played in modern economies.  I did take money and banking, which dealt in what quickly became the old way of banking, as very little of this actually played while the final phase of the bubble was being blown.  Banks went from reserves of Federal debt, recognized as capital, to trading their own credit between themselves.  The real reserves were gone, once the credit of the bankers broke down.  Bankers mistook accumulated interest as profits and paid themselves bonuses out of this fictional profit and used imaginary capital to repurchase stock, for a variety of reasons that I won't touch on here.  

In order to expand a debt bubble beyond reasonable bounds, lenders have to find more and more players and more and more collateral to lend against.  As the debt bubble progresses, the collateral creates itself, as accumulated balances against debt produce purchasing power to speculate on various assets.  Stocks and real estate are the backbone of any credit bubble, the perceived wealth from appreciation justifying more debt.  The bubble bursts when the money represented by the debt is no longer sufficient to pay debt with a positive cash flow.  

In truth, modern finance is nothing but a game on paper.  This is known in modern finance as a ledger or balance sheet.  In this kind of game, what is on one side of the equation is counter balanced with what is on the other side of the equation.  What is on one side is perceived assets, while the other side are what is represented as money and capital.  To the extent the real value of what is on the debt side exceeds the amounts of liabilities on the credit side is known as capital.  If a bank ledger was 100% capital, there would be no credits in existence to pay the debts owed the bank.  To the extent the stated value of the assets doesn't exist, neither does the capital.  Going forward, if the means of repayment of debts on the debt side of banks is insufficient, then the asset values have to be reduced, either in truth or fiction, as time shows who is naked in these matters.  This reduction comes directly out of the capital accounts of the banks, before any deposit balances are reduced, including bonds and preferred stock issued by the banks.  It is the capital position of banks that allow them to make loans, not the reserves that so many people seem to believe lead to money creation.  The money backed by the reserves is already universally owed by the banks to their existing depositors.  At best additional reserves grease the wheels of interbank exchanges and make the decision to lend easier.  Reserves are nothing more than cushions against withdrawals of funds or loan proceeds from one bank to pocket cash or to another bank and little else.  In these times, reserves are basically increased because bank credit is no longer sufficient to carry the amount of debt we have in the system.  

Everything on a bank ledger is reflected on a ledger somewhere in the non-bank world, on the other side of the ledger.  Thus the banks debits are someone's credits or liabilities and their credits are someone's debit or asset.  The capital position is recognized as an asset in someones stock portfolio.  I know stocks sell for more or less than book, so the private account would need to be adjusted for an entry on both sides of the ledger to recognize this excess value, sort of like a paid in excess of par account along with another account on the credit side to keep the transaction in balance.  Being the bank balance is supposed to represent what is really there, as it is a direct accounting of financial assets, what exists on the shareholders balance sheet should reflect book plus another account.  This only to clarify what I am describing.  Thus the loans of banks are the liabilities of borrowers and the deposits in banks are the cash and other balances of depositors and other creditors.  The entries on a bank ledger can be reflected contrarily on the balance sheets of thousands, millions and as to the TBTF banks, hundreds of millions of people and institutions.  

This balance sheet idea is important if one is to have any idea of where we stand and how insufficient the current solutions to the problem are to its solution.  The entire world is based on a modified version of vendor financing and there is one thing that isn't recognized.  That is every financial intermediary is liable for the performance of its assets.  The bank ledger is comprised of loan assets on one side balanced by deposits and other borrowings and liabilities of banks and the liability of the agent bank to its principal shareholders.  Nothing can exist on the credit side of the balance sheet that actually exceeds the value of its assets and the reduction in assets must be borne by the bank itself.  When the loan is made, the bank becomes liable for the proceeds of the asset it places on its balance sheet.  Thus it acts as surety for collection rather than lender and the process is called credit, for the entry on the credit side of the balance sheet.  Any failure to collect must come from the credit side of the balance sheet.  

Extend this around the world and you find the surplus exporters vendor finance the deficit importers.  To the extent the importers can't pay, the balance sheet of the exporter must be reduced.  Then there is capital investment, which is more like a non-recourse loan, where the investment itself determines repayment by performance.  The current situation in Europe is a illustration in miniature, as Greece's debts are in part the vendor financing of German and other exporters, which have merely changed collection agents.  If you stop the vendor financing, then you stop the flow of goods and you may stop the capacity to pay, as they were already borrowing to pay what they acquired.  This can be counter balanced by the foreign investment of Greek citizens into Germany, but this feature is much harder to tie down.  The same goes for the US and China and I would venture US citizens and institutions own a much larger share of the asset base in China than is represented by the debt of the US, but only if you can keep both economies inflated.  To a sizable extent, growth in China has been financed by foreign investment as much as trade.  

To take this idea further, in regard to banks, the only money there is to pay anything on the debit side of banks has to exist on the credit side.  Loans are greater than deposits and other bank liabilities to the extent of capital minus capital assets on the ledger.  Thus, the real estate the bank occupies that it owns is a reduction of the gap between liabilities and capital.  

This brings us to the $64,000 question or maybe the $6.4 trillion question.  On what balance sheets are the credits for the debits of the banks?  The depositors possess the means to pay these debits and no one else.  Even if the government injects money into banks through borrowing and financing, this remains true.  Thus, if the balance sheet of those that own the income producing assets are enriched by government spending through doing business with increased cash balances, the bank is still liable to those that don't need the money to pay.  But, what about the people that owe the loans?

If someone owes money and they have the same amount of money in the bank, then the game is a wash.  If they have more money than debt, then they too end up on the surplus side of the equation with the person with deposits and no debt.  But, the person who has a ton of debt and little money, he is insolvent to the bank, no matter what his other asset base might be.  He is then faced with selling what he has to those that own the deposits in order to gain possession of cash to extinguish his debts or there is no remedy or potential to pay the debt.  He can sell labor or physical assets to pay the debt over time or he can default.  As long as cash balances increase in the accounts of debt free or high cash surplus individuals, those that are net debtors to cash are unable to extinguish the debts they owe.  On a current basis, the debit entries of these debts on bank ledgers are pure fiction.  

What would have to happen for these debtors to make good on the money and capital on bank balance sheets?  For one, the individual or institution would need to have the means to produce income and liquidation  of assets sufficient to live and pay the debts down.  If they had the assets, they could merely sell them to someone who has cash and pay the bank and the credit side and a like sized debt would be done on the bank ledger and the cash and the loan would no longer exist.  But, if they had to labor, absent an increase in pay, which in itself depends on credit expansion to a great extent, they would have to reduce their expenditures on non-essentials to the extent of the debt plus the extent of their prior deficit spending.  This is simple math in a way, but it is not only important, it eludes the general economic arena today.  

What has transpired over the last 50 or more years has been an accelerating equity extraction from housing and other real estate through leverage.  Consumers have been doing a modified version of vendor financing through equity extraction by refinance or contracts for financed sale of housing for years.  This practice accelerated in the 2000's and eventually equity disappeared and the loans became in doubt.  What else went with this procedure was the credit standing of people and their means to repay current and future debt that existed prior to the busted bubble.  These people, which included a sizable share of the first worlds population, no longer had the means to spend or repay, because of the end of Ponzi financing of home equity. This additional money greased a lot of financial wheels around the world and the game no longer functions.  Their capacity to borrow and spend has been sucked dry.  To a very large extent, these are the people who list on their credit side, the assets or debits of banks.  Selling the house is no longer a remedy.  

This is the essence of deflation.  Cash is capitive and it cannot exist beyond the extent of the assets on the balance sheet of banks and other institutions.  Thus, the writing off of debt is by itself a reduction in money.  There is very little difference between a pretend and extend loan and one that has been wiped out through default.  Banks and governments know this money doesn't exist, but they have no choice but to extend and pretend.  

The great secret about Greece is that not only are they having problems refinancing their debt, but that their economy is faltering with a 7.5% of GDP budget deficit.  A shrinking debt base is what is needed to fix this mess, but shrinking in itself produces more shrinking.  In the long run, there is no money on a banks ledger in excess of its good assets. The other reality is if they lose the capacity to create new credit, they also lose the capacity to produce what allows for the payment of interest in general, as interest is never created.  I theorize that the monetary base, which includes accumulated interest will shrink to wipe out all accumulated interest since the last great depression.   This is all credit as well. 

Monday, July 18, 2011

They Have All Been Sucked Dry Part 1

I wrote this on market ticker somewhat as a sarcastic response to what Karl Denninger, the host of the site said in response to another poster.  I have been wanting to write a post labeled "They Have Been Sucked Dry" and this would a good part 1 of such a post.  Guys like Krugman are probably right, if you could keep a straight face and let the government spend $10 trillion extra a year, but that would be absurd to say the least.  The world can't exist in absurdity for long, as nature will correct such an error.  

KD wrote..
Oh no they don't. The wick burns at the same speed irrespective of your dreams. Just as with economics and fundamental math, the speed of a cannon fuse's burn is controlled by the formulation of the powder in it, and nothing you can do - including dunking it in water - changes it once it's lit.

I beg to differ some on this. I held and lit enough fire crackers when I was a kid to know that some fuses suddenly went off. This is known today by the term, the shit has hit the fan. We will wake up one day and suddenly realize the bomb has gone off. I think it has already happened. Some days, I realize what is coming and start looking for a place to hide. There may not be one.

Some people keep looking for an event. Creditanstalt wasn't an event.

What caused the Great Depression was the same thing that is going to cause the depression they are hiding from us right now. That is pretending that bad assets or loans are good assets. Creditanstalt merely was the first crack in the dam to go. The site has a little book called "The Bubble That Broke the World". I don't know really how accurate the book is, but it discusses a series of actions that were intended to cover up the debt that couldn't be paid, namely the British and French war debts, which were being covered up by the German reparations. The US was loaning money to Germany so they could pay France and Britain so they could pay the debts to the US banks. The US got in the war so they could loan money to Britain and France. One bad debt to cover up another bad debt.

The purpose of all this lending was to finance the big trade surpluses that gave the appearance that the loans the the US were good and the bubble in the US stock market was real. Japan ran into this same mess in the late 1980's, where their bubble was supported by ever growing balances of trade with the US. The US caught cold in a credit crunch in the late 1980's and the Japan bubble broke. The Great Depression was worst in the US, because the US depended on the trade dollars for its economy. These trade dollars would have never materialized if the pretend and extend mess hadn't have happened in the first place.

The roles are now reversed. China buys US bonds because it has a dance to maintain. Revolution in China is probably the alternative. If China refused to buy bonds, what would they do with the trade dollars? They would have to spend them, thus possibly wiping out the capital they need to acquire to modernize their economy and support their own phony debt pyramid. The same holds true with Germany, which exports more goods than any country in the world. What is maintaining Germany's exports? Loans out of German banks to the customers of German corporations, most likely. The debts of Italy, France, Spain, Ireland, Portugal, the United States and Greece among others are the result of the big surpluses run in Germany.

There are lit fuses all over the planet. Consumer credit is rampant in Brazil at rates that compare to the paycheck and title loan sharks on every corner in America. The TBTF banks around the world are all being supported on pretend and extend accounting. The solution is to loan governments money to support the economies to support the cash flow to the banks so they can cover up the fact their assets aren't good. One of them will blow and they will be blamed for the systematic insolvency that permeates the entire system.

There seems to be a lot of fingers pointed at LEH. Do people forget that FNM and FRE went broke. That AIG went broke. That Citi was broke. That WAC was broke and most likely the other banks. That MER was broke and that most of the banks in Europe were broke as well. The insolvencies were probably in the tens of trillions, not in the couple of trillion that has been throw into the pot.

The purpose of this mess isn't only to kick the can down the road, but to cover up the crimes of the system. Had they gone through the banks in 2009, how many of these bankers would have not been put in jail or at least had evidence that they should be in jail? I would venture there are plenty of regulators as well that are guilty of wrong doing and would have been swept out into the street. But, the real fact is that the system under which we operate would have been laid bare as faulty and because it is the system devised by the political class and the elite, that wouldn't have played well on main street.

The problem of all of this is the assets of the intermediaries are the assets of the customers as well and the liabilities of many that can't pay. It is okay if Joe takes a haircut, but I want my damn money. That is the thought process of the average person and you can't blame them.

I doubt the typical financial asset is worth 10 cents on the dollar if it had to be set up and valued to operate in a sustainable credit world. The system is geared to mass mismanagement and not to the capacities of sound business and personal finance practices. The only thing that keeps most of what operates out there afloat is prolifigate credit extension to many that can't pay. This, of course, includes the governments around the world.

At what point does sound reasoning move to sound reasoning from fantasy land? Is there any sound reasoning that can follow the statement I heard Obama make last week, "that responsible countries pay their debts", so "Lend me another $2 trillion so the US can pay theirs"? The man is either a trained liar or totally delusional. The US ran up a big debt after world war II, but in doing so, it enriched its citizens with the debt itself. Time had liquidated the debts of the depression. This is not true today, as the debts being taken on by the US government are an attempt to make good the debts of the people, the inflated values of real estate and stocks and the international trade and debt game that has already been financed beyond reason. At some point, we are going to wake up to find the fire cracker that was barely lit the night before has gone off in our hands.

Thursday, April 14, 2011

Could the Fed have solved half the problem?

I can't say I have an intimate idea how banking works, but I believe I do have a general idea.  The link above is to commentary by John Hussman, whom I find to possess some of the best publicly available knowledge in finance.  After not reading his site for some time, I visited it today.  This is his most recent article.  It is worth a read to digest how Fed policy is perceived to work.  I will try to window dress how I perceive banking to work, so one might get an idea what the Fed can do for banking and what it can't do.

What the Fed can't do is make bad loans good.  I am bearish because I don't believe the world can solve its debt problems without systematic pain of massive defaults.  Otherwise, the age of free men will come to an end as we have governmentally enforced peonage to a small group of bankers.  It appears that bankers are only responsible for making bonuses and not for making good loans any more.  Bad loans are the borrowers fault, when in fact, bankers and other financial organizations have succeeded inflating and loading the world down with so much debt that a large percentage of it merely rots on the vine.  This would be true whether we had sub prime mortgages or not, as the level of debt at some point becomes much more important than the quality of debt.  In fact, the sub prime lending may have prevented the current process from starting earlier, like at the end of the dotcom boom.

In any case, what a credit crunch involves is the inability of one group of financial entities to attract funds from another group or the public at large to satisfy their liabilities.  Banking was supposed to be structured on the basis of reserves held in cash and treasury securities.  These items could generate rapid liquidity by being presented as payment or redeemed for funds at the Fed.  Thus a bank that needed to raise funds would have a very liquid asset in the form of a bond or t-bill to go to market and raise cash.

What occurred in the bubble was the fact that one bank was lending the other bank their liabilities.  When banks interact, it is generally through their customers.  Thus if bank A creates $100 billion in loans and only attracts back $80 billion in deposits, it has to cover the other $20 billion somewhere.  Should the extra $20 billion end up in Bank B, B generally makes A a $20 billion loan overnight or for a period of time.  The $20 billion in B is on its balance sheet as an asset, but it is really a liability to a customer who received the money from the borrower linked to Bank A.  Thus, A is now liable to B who is liable to its customer who received the funds from a customer that is liable to A.  The whole circle is a series of liabilities, none of which are really assets  The circle has to be closed or the domino's fall.

In the crunch, the banks were insolvent.  They are always insolvent, but they can present solvency as long as the circle works.  When massive amounts of assets of Bank A suddenly turned sour and lost their marketability, Bank B began to doubt the immediate solvency of A and took its money back or asked for higher rates.  A couldn't sell its mortgage or whatever it had as collateral for the loan and thus was in the midst of a credit crunch.  If A possessed a pile of treasuries in the amount of its liabilities, it could have sold them and solved the problem  But, A was actually operating with near or below zero reserves, its entire basis of existence borrowed from the market.  It was no longer a bank, but a finance company.

The US operated post world war II for about 20 years before there was a financial accident.  The war flooded the system with treasuries and gave the banking and private sector massive amounts of redeemable paper.  The treasury holdings of the banking system began to run short in the mid 1960's and was pretty much all used up by the mid 1970's and bank had to invent ways to pretend they had reserves.  If one examines the amount of currency of the US that has been printed over the years, they have to make the educated assumption that the money left the banking system long ago.  No bank would sit on that much non-interest bearing cash.  Thus the reserves stated on the balance sheet were gone and replaced by a customer liability that was once represented by the cash.  Thus the structure of reserves was merely banking IOU's passed between banks and bank customers.  The system of liquidity was replaced by a structure of derivative swaps that I really can't tell you how they work other than to say they are swaps of different interest rates and calls and puts on treasury securities.

The too big to fail banks all took advantage of this financial innovation and pushed their balance sheets to the limits, becoming liable for very sizable amounts of overnight funds.  This system has very little implied guarantees, the guarantees being the government, the Fed and the FDIC would take actions to prevent the system from failing.  This system operates, not only in the US, but around the world.  The dollar being the international mode of exchange, banks in every developed country are involved in the interest rate swaps, overnight loans, etc.

Getting back to the Fed and QEI, QEII, TARP and all the other alphabet solutions, we arrive at the junction of what this article describes.  The purpose of all of these programs was to allow the banks to cash their checks.  Nothing else.  For all practical purposes, the cash in the form of Federal Reserve notes had left the banking system, along with the supply of treasuries, years ago.  As I stated, banks were lending liabilities to each other or should I say lending what they were liable in exchange for a liability of the other bank.  The circle had to be completed.  Once the insolvent borrowers broke the circle down, the offending banks with the offending customers broke the circle, as for the circle to be complete, all liabilities in the circle have to be good.  Thus, when the call went out, the supply of treasuries for liquidity were also insufficient to supply the demand implied by the chain of derivatives.  The financial engineering couldn't stand the test of time.  Minsky brings a lot of this to light in his book Stabilizing an Unstable Economy (I could have misquoted the exact title), that financial innovation leads to credit expansion which leads to instability.

In these alphabet soup solutions, the Fed used what might have been doubtful assets to create money for banks to pass around between themselves.  I propose that very little of what is called reserves is to be used for customers, but instead for cashing liabilities between banks.  This money is mostly used to limit what banks can do in excess and thus once out of real reserves, the banks balance sheet has to be good or the system collapses.  The receiving bank lends back the reserves in the Fed funds market, thus the lending bank makes loans indirectly for the receiving banks.

This is a rabbit out of the hat trick the Fed has pulled off.  For one, the Fed couldn't just go into the market and buy existing treasuries, thus taking them off the market, because the derivatives market presented such an implied obligation to deliver that they would have dislocated that market as well.  Thus, they had to wait for the government to produce the treasuries.  I am not forgiving the prolific spending by our government, except to say that the credit had to come from somewhere.  Upon cashing these treasuries, the Fed created the implied cash for the banking system to buy the treasuries back from the Fed.  Just as world war II presented the same opportunity, the recession did the same.

If you read the article, it implies to get to a 2.5% interest rate, the Fed is going to have to sell about $1.25 trillion in treasury securities.  The money is now in the banking system.  The great magic of treasuries, especially t-bills, is they equate to cash and to reserves.  They give the banking system the fodder to cash should they need cash for their liabilities.  So, it appears for the time being that half the equation has been solved system wide.

But, this does not address the other side of the problem.  The other side of the problem is that who holds these reserves and who needs them are two different animals. Reserves only mean something if the conditions exist for the banks to extend credit.  I am going to propose that the banks that have the worst financial position are not going to fall over themselves to make further loans, because they are not going to expose themselves to running out of cash again.

I believe a bank is like a guy with a pocket full of charged up credit cards.  As long as his checks cash, he is solvent.  He may even be able to keep his credit pristine, save for being viewed as over-indebted.  If he has a house, he might even be able to solve is credit card problem with an equity loan, thus putting his payments on a lower interest rate and a longer payment schedule.  But, he might have a fancy car, a fancy house and be broke all the same.  Especially if something happens to the market price of that house and should he find himself living beyond his means again on credit.  As long as the checks cash, he will be perceived as having a net worth.

A bank that has made a lot of loans is incurring liabilities as they are making loans.  If their liabilities are leaving the bank faster than other banks liabilities are coming into the bank, borrowing the liabilities of other banks through their customer base or through the bank has to go on or they have to sell some of their own exposure into the market.  One of the things that hit the big banks was having to take their seemingly limited exposure represented by the SIV's they agreed to fund onto their balance sheets.  I don't know a lot about these instruments save to say that they were likely pass throughs that involved assets to be put into CDO's and ABS's where the market flat dried up.  The asset based commercial paper market imploded and the only way to fund this stuff was through the balance sheet of the bank.  Of course, the money had to be paid to the money market fund that was redeeming and not rolling the paper and the funding requirement of the bank itself went off the cliff.  There was no money to write the check, hot or not.

Hussman implies that the US made the same mistake as Japan, not solving the solvency problem.  I tend to believe the solvency problem lies with the banks customers and the expansion of debt on the public side of the  equation isn't going to solve the private side of the equation.  Instead we are going to find ourselves in a long term liquidation process that will slow the economy and make debt increasingly difficult to pay and credit less and less attractive to the private sector.  Banks are going to engage in speculation in assets and find themselves permanently cornered as the Japanese banks found themselves in their own stock market.  I propose the interest might be short dollars and to unwind that position is going to take years of deflationary symptoms.  This is what the system of liabilities are, a series of dollar short, borrow to buy, lend to earn interest, etc.  The very act of having to cover the short prevents the price of the asset or whatever one calls a dollar from going to zero.  Once the treasuries are put in the hands of the banks, the requirement to produce cash for them will be absolute.

So what is going to solve the problem?  I don't see any short term solution to the debt problem other than a debt for equity swap, in the sense that the losses are socialized, first by the wiping out of equity of the owners of the various financial institutions or the dilution of them with the depositors, bond holders and such taking additional equity positions.  The government might decree that Bank A has $1 trillion deposit and bond liabilities and $900 billion in good assets, thus is $100 billion insolvent.  Next, they might decree that the deposit liabilities are reduced by 50%, that the shareholders in Bank A are declared wiped out and the depositors and bond holders now own the bank on a pro-rata basis.  The market would solve the rest, as those that wanted to withdraw their money from the bank would merely sell their newly issued stock and the bank itself would now have $400 billion in capital.  There really isn't any other way out of this mess that would solve the problem short term.  To expedite matters, the existing shareholders could be placated with a 5% ownership share in the new entity.

I am really curricula to see how this works out.  I doubt the politics of the situation are going to allow for any kind of real solution other than the continued perpetuation of zombie banks.  The bet here is that the banks can earn themselves to solvency before the economy collapses under the weight of massive debt or the government goes broke.  I am betting against it because the system itself is broke on a current basis and the other parts of the system, banks and government, can only draw their solvency out of a solvent system in general.  This is not merely a condition of the US, but the world.  In fact, the insolvency of the rest of the world has been covered up for years by the increasing ability of the US system to produce credit and remain solvent on a current basis.  Thus, the Fed has succeeded in one matter, allowing bankers to cash bad checks for themselves and others.

Tuesday, March 29, 2011

The Fraud of Banking and the Educational Smoke Screen

I wrote this post as a response to an article I find much agreement.  While not dispelling the comments about Fractional Reserve banking, my attempt is to center the discussion on what banking actually is, a system of liabilities all of which involve the bank, in that in truth they have no assets other than what they can post as true capital.  
The sad point Pater is the worse this situation gets, the more actions the governments of the world take to cover up the fraud. I don’t even believe in the term fractional reserve, as it is even more extreme than that. The term is actually deficient, as the reserves in the banking system are nothing but credits of other banks. The cash represented by the Fed balance sheet doesn’t even exist in the banking system, but has already been paid out by the banks and is in hoards around the world. This doesn’t mean it is not available for deposit, but that it doesn’t exist on the balance sheet.
The only way a true run on a bank would be successful is if the runs were universal, thus the money not redeposited somewhere. But, absent a guarantee, anything that had to be cleared through the system likely would be demanded by the receiving bank in cash and the liable bank couldn't pay. Reserves follow credit, not precede it. In fact, as long as there is not a second bank involved, the originating bank can merely shift money from one account to the other as it changes hands between customers. I suspect that within 10 years, only interbank transactions will be allowed and the idea of pay to the order on demand will be lost. Such is the lure and power of a perpetual fraud.
In truth, I don’t believe reserves exceed the capital of a bank. In order for there to be any legitimacy in banking at all, the banker has to have skin in the game. Otherwise, he is merely lending his own IOU’s. I have a document somewhere that was filed in Federal court which lists the court cases in the US that forbade a bank from lending its liabilities. The rulings mentioned on bailment border on absurdity, as the money on deposit at the bank is clearly a liability of the bank and not an asset. The great secret is the entire balance sheet is nothing but liabilities. The bank is liable for its asset in that if they don’t perform, the bank has to perform. They made themselves liable when the created the loan. They are liable for the loan, not the customer. The customer has merely pledged his credit or his collateral.
The banks assets are only good to the extent the borrowers on these loans can acquire the liabilities of the banking system. There is no other species in circulation other than the coin of the United States or whatever other country is involved. If the Fed is creating new deposits by financing the treasury directly, then these are also bank liabilities. This runs a lot deeper than the nonsense that the problem with banks is a mismatch of maturity and runs directly to the solvency of assets on the balance sheet. These assets represent the banks liabilities and if the bank can’t be liable for the losses on the assets, then under any imaginable form of law, they aren’t a legitimate business, but a Ponzi scheme.
The system of credit doesn’t bother me as much as the fraud that is going on about the solvency of the banking system. That any regulated industry that is likely short of capital should be allowed to engage in partial liquidation of its capital positions disturbs me. They call these stock buybacks, but what they are in truth is a liquidation. Lets see what happens when the FDIC serves its purpose of guaranteeing deposits and not the other sources of financing in the banking system when a partial liquidation is undertaken? In a free market, I have to believe that the bond holders of the banks would get nervous. They maybe already have.
The incapacity of the regulators to enforce haircuts in the system, as opposed to bailouts is astonishing to me. For all practical purposes, the 4 or 5 largest banks in the US should have failed. The shareholders should have absolutely no interest in these institutions and the officers of these institutions and their financial practices should have been investigated. The bondholders should have owned the banks in reorganization and in most cases, the deposits wouldn’t have been touched.
I bring this last point up because the only way to have saved this ponzi system was to destroy its components in the short term. The haircuts are not optional and it is clear they are planning on taking the losses out of the side of the depositor and not the banker. The entire rule of law has been stood on its head in this instance, going back to the cases that Rothbard mentioned in his book, the mystery of banking. I need to read the remainder of that book, but then again I have read the modern story too many times.
One more thing. The only truth in the money and banking courses taught in college is that commercial banks create money when they make loans. It absolutely astounds me that the focus of these courses is the nonsense about reserves and the fed doing this nonsense and that nonsense when the only truth that can be gleaned out of this course is that banks create deposits and thus money supply when they make loans. They all get back to what account the bank takes the money from when there isn’t any account. The guy that wrote that rebuttal mentioned above seems to totally miss that idea. Those that talk about fractional reserve miss the point as well. Banks don’t keep reserves, as it is a total nonsense to keep people talking about something. They borrow back what leaves the bank. There are no reserves.

Friday, March 18, 2011

The Knee Jerk Society

Recent disasters, the US/World Banking crisis and the recent atomic/earthquake/tsunami disaster are 2 examples of the head up your butt, knee jerk reactions that are compounding to put the worlds economies and to an extent the survival of civilization itself at risk.  When the dust settles, nothing will be solved and we will face a problem much larger than we had to start.  The banking crisis was met with something called TARP, a huge stimulus bill and monetary tricks by the US Federal reserve that will do nothing but leave us with an unsolved problem that will come back with more force next time.  The reactions over the atomic accident in Japan are just as absurd.

What I am hearing now is that Germany is going to shut down its entire program and Obama isn't going to renew permits to run plants in the US.  There is no assessment, merely knee jerk.  Obama's policy with oil drilling in the Gulf of Mexico, the result stripping the US of its most promising and most productive oil resource over a blunder by British Petroleum is just another example.  The safety record of offshore drilling in shallower waters for the past 50 plus years has been pretty good.  Knee jerk with a 44 magnum in your hand and you can shoot your toes off.  The US doesn't have many toes left and Obama and the bankers are taking aim.  Now our oil rigs are on the other side of the world and a country that is rapidly going broke is looking at cold winters and no gasoline once the end game starts.

Lets start with the Great Financial Crisis and what it really entailed.  Paulson had the country over the barrel and he chose the Japan solution.  Bernanke is choosing the Japan solution.  There is absolutely no recognition of what the real problem is, merely put a plug in it.  The US government had the power to resolve the entire banking crisis, but there aren't many of us that would have liked the immediate result.  Instead, leave the crooks in power at the various institutions, change the rules to allow accounting fraud and throw in $700 billion and let them keep looting.  In the meantime, the real problem, societal insolvency and a lack of a mathematical solution to the problem prevails.  We are being told capitalism failed when in fact capitalism hasn't prevailed for years.  Instead we have an economy managed by social engineers who take very little in the way of reality in consideration.  If capitalism was in force, these failures would have been taken out of the system, the system reorganized, the investors in the failed institutions wiped out and anyone engaged in criminal activity with other peoples money would have been tried and jailed.  The knee jerk was the status quo.  The truth is we are in a serious problem that the knee jerk will only make worse.

The US government has been in a managed insolvency since the Great Depression.  The managed part depends on keeping the on the book debts within reason.  We elect Superman and a group of socialists and what happens?  We have a $788 billion stimulus bill that will keep unemployment at 8% and be a 1 time event.  Truth is we had a $1 trillion a year bill that is going to put the US in permanent bondage.  Just the mention that 10% of this money is going to be taken back and the socialists threaten to shut down the government.  The knee jerk became the norm and the bill was for nothing more than to pump money into public unions.  Nothing was done with the debt situation in the US other than make it worse.  Nothing was done to stop unemployment at 8%, as it went to 10% and only hedonistic adjustments in the employment base and some twisted figures have brought it down from there.  They merely had a couple of clowns and Wall Street crooks come forward and announce a recovery that most of the country has yet to embrace.  The real problem, a pile of unresolved debt in the financial intermediary system, remains.  In the meantime, the Fed has produced more and more funds with which the frauds can continue to write checks and kept interest rates at a level that has induced many to move into junk bonds.  Emboldened by stimulus money, States took actions that now put most of them on the path of insolvency as well.  The spending can't be reversed.  In reality, it will be.

Now we have the accident in Japan.  I am really at a loss to imagine why they would build a plant that could withstand an earthquake and not plan for a tsunami.  This isn't the Gulf Coast, but the land which gave the tsunami its name.  In addition to the damage done by this accident, Japan is going to suffer horribly from a shortage of electricity, the elixir of modern economies.  What is the reaction from this tragedy?

First, the NRC in the US is run by a man whose intent is to destroy the atomic energy industry.  Second, the result of destroying atomic energy will be the end of modern economies and the mass starvation of people in other economies around the world.  We are dealing with a policy of genocide and  are being scared into it.  There isn't a solution to the void that would arise should atomic energy be shut down around the world and the result over the intermediate term will be a world war with widespread atomic exchange and the death of probably 1 billion people or more around the world.  This will come only after hundreds of millions have starved to death in the dark.  Thus the fate we are being frightened with will become the reality as survival will depend on acquiring the energy to run economies and the division of labor and modern agriculture.

The scream has been all of us in the US are going to die from this accident in Japan if we don't take some Iodine pills.  Back in the 50's they blew up atomic bombs like they were fire crackers on the 4th of July and yet there was no widespread death.  Japan survives.  The results are overblown.

I am not here to minimize an atomic accident, but to look at the other extreme.  If we shift to coal, what are the damages?  To produce the electricity these reactors in Japan produced with coal, it is highly likely the entire side of the Island would have already been poisoned.  There would be miles of strip mined land, trillions on tons of carbon foot print, if the nonsense is to be believed and the land around the plant would be poisoned with the emissions from the plant.  This is a guarantee.  This is the choice we make if we close down the atomic industry.

There is more to this.  Where do they get the oil, gas and coal to replace the atomic energy to run the grid.  Oil is already in short supply.  Coal is an ecological disaster and gas is still being developed with new technology.  Plus, the anti atomic people are the same group that are the global warming group and the carbon tax people.  They are most likely also the bankers of the world.

Residential energy is a given, so the slack would have to be taken up by energy used in the production economy.  Get ready for rolling blackouts, massively higher electric bills and a declining standard of living around the world.  These same bastards are going to attempt to manage that side of the disaster as well and most likely use it to establish themselves among the privileged.  While we are cowering under our beds, they are stealing our birthright and crowning themselves with our resources.

Paulson said there would be tanks in the streets.  This is the same story told over and over again.  Give us what we want or we will go broke on you.  It appears the average American has watched so much reality TV and seen so many Hollywood movies that he buys into anything.  I was on a site a few days ago and the solutions being proposed for the emergency in Japan were right out of fictional Superman/Rambo type flicks.  There is nothing to be said for the haircuts that are going to have to be taken.  The question is who takes them.  The bankers have had 30 months to continue looting and to shift the losses to people other than themselves.

Who is going to benefit if we shut down atomic power?  I would venture the same folks that own the electric grid.  They are the same folks that in some fashion own the construction companies and the resource companies and we, the people will pay massive hikes in electric rates to funnel more money into their pockets.  When they are done with the building, we will then pay them carbon credits and the bondage in Egypt will be ensured.

Saturday, January 29, 2011

Pubic Pensions and the Tooth Fairy

It looks like the entire country is being gamed by politicians, unions and Wall Street. This is a prime 3 way example. Who manages the money? Some Wall Street group most likely. What do they get? A percentage. What is the plan? To sell the states overpriced stock. Who is going to gain? Probably no one, as the system is going to go broke. If it doesn't go broke, the above groups, save maybe the politicians who haven't arranged bribes, are going to be unjustly enriched.

So, we have a group that is having 30% of its income saved without any effort. The payout is based on ending salaries. If we have inflation, the ending salaries will go up with the CPI, if not faster. This eliminates the inflation part of the return on stocks. You can't inflate yourself out of these debts, but with 5% inflation, 8% should be available on bonds. This would work if there are no COLA's in the pension plans.

But, inflation increases volatility in the system, because it is the expansion of debt in excess of the growth in the economy. Interest rates will always normalize, Fed or no Fed and the assumptions of expenditures always comes up short of actual expenses. Debt always has to be paid or the principal lost.

The 8% assumption cannot be met without 5% inflation. As stated above, if that occurs, the payout side goes up and you have the snake swallowing his tail. I know stocks are supposed to yield something over time, but this is one more compound equation that cannot work. The financial valuation of stocks relates to what stock pay the shareholder, not what the market will pay for them at any given time. The later of these examples will show up from time to time, but this is what tops are made of, not what returns are made of. We have been in the later to some degree since 1987, with a blow between 87 and about 1992. 3% dividends are historically peak values that are followed by bear markets, as shown from 1929 and 1966. Real returns are dividends plus 1% on the bullish side and history is worse than that.

The point being we have a market that is valued in excess of GDP. GDP grows 3% plus inflation, the valuation of the market cannot grow more. If we are on a bottom and dividends are 6%, then we might be looking at a market valued at 40% of GDP. In that case, GDP can expand at a 3% real rate and the compound formula favors the market. The peaks in 29 and 66 were at 80% of GDP. The 2000 peak was over double GDP. At that point, potential growth would be limited to 1/2 nominal GDP or about 2.5% to 3%. This is not the path to the pearly gates of prosperity.

What is a stock but an open-ended bond with a variable payout? You are promised back zero and because you are promised back zero, there has to be an additional risk factor. Because this is an open-ended security, you can't use a valuation method that centers around the present and instead have to incorporate risk factors that encompass forever. This is especially true of one isn't a professional speculator (very few ever come out of that game intact)and have an investment philosophy of buy and hold. Thus, you can't compare stocks to 10 year treasuries or CD's or any of the sort. If you could find a 70 year treasury bond and add 3% to the rate, this would be a good discount for stocks.

I hope you guys are following this, as I am sure Karl is. A market with a value in excess of GDP cannot grow in excess of GDP forever. This would favor stocks only if the dividend yield was the actual return. But, the valuation model in stocks is dividend plus the rate of growth in dividends, not PE ratios, which are creations of accounting and other nonsense. Earnings do not flow from stocks, dividends do. Earnings go into the reinvestment formula of stocks, but nothing is guaranteed on investment and we are still looking at economic growth at best.

This brings us to the real conclusion that should be drawn out of this assumption. If the market is performing so well, where is the economic growth? China? Who owns the means of production in China? Is it corporate USA? If it is, then the foreign reserves of China actually belong to corporate USA. If it is the USA, where is the growth? Europe is a shrinking market and so is Japan. Thus if earnings are as high as stated, the investments being made are not paying off and we fall back into the compound formula and historical corporate profits, which are now being claimed to be among the highest in history against the GDP. The last record in this factor was the late 1920's. We all saw what followed.

To straighten out what I have written to layman's terms, Return equals dividend plus a maximum of 1% plus inflation. The return in stocks is a straight discount of the dividend with the growth factor subtracted out. To make 8% on the SPX, we would need 6% nominal GDP growth multiplied by the percentage of market value to GDP. Thus if the market was 50% of GDP, we would need 3% growth. If it is 120% of GDP, we would need 7.2% nominal growth. I would venture we are right about 100% at the present, but I also suspect GDP is on shaky ground.

I have thought about a scenario of where dividends would be 8%. For one, arbitrage would scrub that factor out, as long term the risk premium on stocks is 3% above risk free. 8% is about 3% above this factor. Also, 8% would take 75% off current valuations, so the growth would have to come from a lower level, using the current model. Also, corporate profits would have to be around 16% to 20% of GDP in order to support a market valued at 100% of GDP. I doubt this could be supported without there being a more population wide distribution of stock ownership.

Karl used 3% and I support that figure, if for no other reason than that is the dividend plus real growth number. Inflation is a zero factor, as it adds and subtracts at the same time and as I stated above, increases risk. If you are my age, you can recall the start and stop economies of the 1970's, where we had 2 recessions like the one we just had and a couple more in about 14 years. People under 40 haven't seen this mess before, but those of us between 48 and 60 came of age in this mess.

If someone wants a model that would support a proposed 5.5% real rate of return, they probably need to wait for stocks to trade at about 50% of current values and for the debt problem to be cleared out. This means the 2009 bottom was the buy point and nothing above that, save for some very select shares. What is going on now is nothing but pump and dump and it would be wise if the States kept their money out of the market, instead of the forced buying at double the price to achieve the return. Time won't fix this, as the purchase of stocks are a purchase of an open-ended security where you buy a return at the time of purchase and the tooth fairy doesn't show up to fix your mistake. At some time, the market is going to revalue, most likely when the world economy is going to be forced to deflate or collapse. Then it takes 14 years to break even on a 50% loss at a 5% growth rate. When we leave these valuations, it will be another generation before we see them again.

Wednesday, January 12, 2011

Welcome to the financial circus of lies

I have read books like Manias Panics and Crashes. I never understood what the banks were doing back in the 1800's until I saw this. This is bigger than subprime. Bernanke will be hiding under his desk in a PTSD fit when this one hits. We just think Paulson looked like he was about to go to jail. 

Charles Smith at Oftwominds wrote a parody the other day. He was using Bush's quote, "This sucker is going down". We are about to see the biggest bust in history. It isn't only the banks, but the governments and the corporate buyout guys. I heard a bull on CNBS this morning say how you could get more for a company with borrowed money than it was selling on the market. That should always be true, but that is beside the point. It is true for 2 reasons. There is no broadbased dividend return in the market and the risk premium on stocks is higher than the risk premium on the bonds of the same corporations (unless they have adopted the GM bankruptcy model). The point here is the higher up crooks are using Ben Bernanke dollars to loot the best deals. Hot pressed money! Michael Hudson said this was what EBIDA meant, how much can you borrow and take out? To hell with the real losses!

I wonder how the banks are going to bank this next sub-prime crash, the junk bond insolvency? The Fed posted a 2010 profit to the government of nearly $80 billion. Think Congress is going to take their punchbowl away? Of course, they are hiding their own losses in Maiden Lane and the mortgage pool they bought. When we going to find out about that? It is clear to me that the Fed is moving out on the yield curve to produce income as much as to support the economy. You can't earn any money at zero and I would hate to believe these guys want to be left out of the party and would like some credit for sending the government a big check. But, this is $80 billion that now can't be paid by other parties and probably $80 billion for Wall Street in the end. 

The pretend and extend that is going on in Europe is going to eventually infect the core, Germany and France. This is nothing but another case of bank socialism. Japan joined in, isn't that funny? Black Swan at Mish said it was a move out of the dollar. Bullcrap. See these charts linked to default swaps on the JGB.

We have a series of back scratchers here. The Japanese are buying into the Euro rescue because when this stuff is going on, the world recognizes how far in debt Japan is. It is noted they have a little over $1 trillion in foreign reserves, but they have a $5 trillion haircut coming in their debt. If you look at the first portion of the chart on the JGB (the light colored line on the second chart), it is revealed that this isn't the first trip up the scale for Japan. You might recall the last trip was to even higher rates. Care to venture what effect systematic risk in the JGB would present, as we are looking at a 70BP swap on a security that yields around 1.5%? Does anyone actually believe China bought the JGB's in the spring and summer because they wanted to move out of the dollar? We all know how much the Chinese and Japanese love each other. Of course not. They judged it cheaper to take the haircut later than take the shock at the present with their overbuilt, over extended economy. 

All these governments are fucked. As much money as Ben bernanke is printing, it can't get to the right places and is instead laying there for financial thieves to convert to their own. The banks are banking uncollected income, which we all know is none at all. The leaders in Portugal are pretending they are solvent. The bankers are goading the other governments in Europe to bail these guys out in the name of the Euro. What the hell is the Euro? It is a bank note.

Now we enter the ultimate paradox. The broke have to pay higher interest rates. You might recall the TED spread and how the idiots on CNBC kept talking about it. Banks won't lend to other banks. Would you lend to Citi without a government guarantee? Chase, Goldman? Japan is 200% of GDP in debt on their government bonds and they are borrowing for next to nothing. What happens when the swaps go to 3%? Well, their entire tax income is dedicated to paying interest. Is this the goal of the financial crooks, to place the income of the world to paying interest to them? If this is the case, then we have only genocide to follow, as there will be nothing left for food or consumer goods and the entire scheme collapses.