Nom de guerre: Rivrdog

Cash is King

Has it occurred to anyone else yet that the entire world is operating on cash, in it's various forms? Since cash's role in global commerce is relatively minor, there must be a time limit on how long the world can run on it's accumulated cash.

Of course, when the cash runs out for the Bigs, they just run to their friendly gummint wallah, and get a "capital injection". For everyone else, running out of cash is going to mean closing the doors. The part of the economy which runs on cash is probably well less than 10% of global business. If it doesn't run on cash, it runs on credit, and now that credit is shut off, the clock is ticking.

The world's economies can't sustain themselves on cash.

I can sustain myself on cash, probably until well after the rest of the globe grinds to a halt, simply because I saw this coming. Actually, my FATHER saw it coming about 40 years ago, and convinced me to forever be ready for it.

The difference between the cash economy and the credit economy is a multiple, known as "leverage". Some leverage has to be allowed, but the absurd multiples of leverage that the likes of Goldman Sachs and Lehman Bros run/ran on cannot be sustained. The market proved that yesterday when it bid $0.08625 on the dollar for Lehman Bros Credit Default Swaps.

My guess is that the market will support a revised leverage system with leverages of no more than 10-to-one. When that is agreed on, and the companies out there who have leveraged well past that have all failed or been nationalized, then the world will get back to business.

Not until then.

I think that won't occur until the Dow gets down below 6,000, but some who follow it say that number will be between 3,000 and 4,000. Any rally at the present 8,000+ level will be short-lived, as the governments do NOT have enough "good faith and credit" to maintain such a high rate of leverage in commerce.

There's more of this ride to go.

Hang on tight.

Psych yourself Plastic

No, I haven't been inhaling any of that whacky Oregon Smoke.

Those three words in the post title sum up what is happening to the stock markets now.

In the past 2 weeks, I have watched almost 100 hours of CNBC, which, despite  being part of the politically twisted NBC empire, is actually just a technical money-and-banking network, for the most part.

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UPDATE:101008: 1910 PDT: On CNBC, a talking head, referring to a Newsweek poll that said that Americans are still against the bailout(s), cross-referenced the stock market collapse by saying "they've voted with their dollars because they couldn't vote with their votes" (against the bailout).

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Everyone on the channel agrees, and I believe them, that the huge sell-off in the markets is due to the freezing of inter-bank and inter-corporation credit systems. With no money moving around the system, commerce in the global economy is grinding to a halt.

Today is the day that the bastardized system of inter-institutional credit known as Credit Default Swaps gets tested. The CDS' of the bankrupt Lehman Bros investment and brokerage house are auctioned today to the Federal Government, but they are being bid on in an open process. So far, no one has even bid a dime on the dollar for these insurance policies which guaranteed the "leverage" or margin of credit upon which Lehman Bros. operated.

So, the Treasury Dept, which will own what used to be Lehman Bros, will get less than a dime on the dollar for whatever that formerly-huge investment empire owned. That means you and I just got stuck with the proverbial pig in a poke.

That's what I refer to as the "plastic economy". Leverage, plastic, all the same to me and to the rest of the Joe Sixpacks who are watching the trillions in plastic money melt down as the days go by.

Either today or Monday, Wall Street will pass a negative milestone: the Dow Jones Industrial Average (of 30 selected stocks) will have fallen in value by 50%. Half of that index is gone, and YOU AND I ARE BEING BLAMED BY THE "ELVES"ON WALL STREET FOR THE DEBACLE !

How could it be our fault, you and I ask?

It isn't, but those elves (and the tycoons who hire them) know that it is the individual investor, not the institution, who is best positioned to survive this crash. We have simply pulled our dollars out of the game, and with shotguns across our laps, are just sitting it all out. We have passed up some mighty tempting opportunities to jump back in to the markets, and we are getting to be hated for our decision.

WE KNOW WHAT THE BIG MONEY BOYS CAN'T EVEN GUESS AT: the "leverage" is the culprit, and until the crash wipes most or all of it out, we're not going to play the game again.

Let's look at the numbers. Lehman played the game at 25-to-30 to one leverage. The Dow was about 14,500 a year ago when they were in. They're gone, and the Dow dropped below 8,000 for a while today, which means that the leverage rates are almost cut in half.

I studied the Crash of '29 just like Ben Bernanke did. We probably read the same reports. He got a PhD out of his studies, while I only wrote a 40-page Senior Thesis in high school for mine (got an "A", though!). Before the Crash of '29, ANYONE could use "leverage". You could play the stock market on "ten percent margin", which means you were leveraged ten-to-one. Now the brokerages which took your leveraged order (by Western Union telegram) then ALSO leveraged THAT business out at ten-to-one, making the final leverage one hundred to one. With that leverage, the market went away QUICK when it went away. BTW, guess what company ran most of that empire?

Goldman Sachs.

OK, so after the Crash of '29, it was decided that no one could leverage any worse than two-to-one again, but that rule has been watered down by the invention of the sleight-of-hand Derivatives Market, which instruments are nothing but leveraged bets on movements of the price of real equities and commodities. When the Commodities Contracts seemed to do alright with their large leverages, the idea of those futures contracts spread to futures on actual equities, so when "spiders" and Hedge Funds were developed, the huge levels of leverage came back with them.

With today's auction of the Lehman Bros CDS', the free market has decided that it will pay for leverage at a rate no higher than ten-to-one.

The free market is limiting leverage, but until the entire market corrects to the free market indications, the slide in value will continue.

So, in answer to my question of "where's the bottom", I propose that the bottom is when the leverage is mostly gone, when the plastic is mostly melted, and when a dollar invested buys ONLY a dollar of value in a company.

I'll do the math for you. If the Dow companies were leveraged at twenty-five to one, their par value at no leverage would be 580 (based on their aggregate high of 14,500). If leverage at ten to one is OK, then the "bottom" for the Dow is 5,800.

If the free market is going to accept ten to one leverage (and that number is traditional both here and abroad, BTW), then it must understand that the TOTAL leverage in chain transactions must only be ten-to one, not as in 1929, ten to one, then leveraged AGAIN at ten to one.

Oh, and watch Goldman Sachs like a hawk. That outfit did it to us once, 79 years ago, and their proteges sit atop our government regulatory agencies now (that would be Paulson and Bernanke).

So, if you will excuse this untrained, under-educated blogger for making such a technical prediction, the Dow has another two thousand to drop before the little guys get back in. For me, and I suspect a lot of others, it's a cash economy until then.

If investment were to resume soon at high leverage rates, any "recovery" we see will not last, and the markets will fall off the table again, only the next time, the cash economy might not hold the fort as it's doing now.

If the government regulators ARE going to tinker with the "free" markets, they need to tinker on the side of getting the plastic swept out the door of the Temple. If they encourage resumption of the Plastic Economy, they have failed us, and themselves. So far, they have done very little to discourage the use of high leverage. That must change.

Bottom, bottom, where's the Bottom?

No, this isn't a porno page. The "bottom" I'm referring to is the end of the current market slide into oblivion. Will it end in "oblivion"? What is "oblivion"?

Some market elves on CNBC seem to think that "oblivion" and the bottom are one and the same, and are at around a 7500 Dow, or another 2,000 points lower than today's drop ended at.

It's all psychological, at this point. Investors large and small are psyched out of the market, and banks have taken such a beating (Bank of America lost 24% of it's value today alone) that they aren't loaning a dime to a millionaire.

So, the bottom is a psychological thing, too. That why Bernanke and Paulson just bet 1.6 Trillion US dollars that they could firm up that bottom by spending taxpayer money (or printing some taxpayer-backed currency).

It appears that their little gamble didn't work today. It might not work tomorrow, either.

Here is the answer, learned economists, if you care to hear it:

The market is too complex for the average investor, and rapidly becoming too complex for the institutional investor.

Why is it so complex to put one's money to work in the market? One word - derivatives. Derivatives are basically any sort of financial trading instrument that isn't either a stock (equity position holding in a company), or a bond (promissory note of a company or government). Derivatives have strange names: "put options" (a bet that a stock will fall), "call options" (a bet that a stock will rise, a "short-sale" (a bet that a stock will fall, and that you will get the difference between the old higher price and the lower sold price).

Then there are futures contracts for commodities (sort of in-between in that you are actually contracting for the right to buy an actual product, such as soy beans, at a certain price in a time certain, but you usually don't expect to take possession of the commodity). Where it gets complex are the derivatives based on these futures contracts.

So, to me, the solution to the market crisis, both the actual cash crisis and the crisis of confidence, is to limit derivatives trading. If we're going to take control of the markets, as is happening all around the world, let's not only take control, but let's put trading back to where it started: you get equity, or you loan money to companies and get their IOU, and that is all we trade. Futures trading would be allowed for actual consumables: food, fuel, materials like metals (not "carbon credits").

If Bernanke and Paulson were to shutter the market except for equities, bonds and commodities, even for a test period of say, 30 days, the remaining market would rebound. The gamblers would have to fly to Vegas or play the ponies at an off-track betting parlor.

The value of shares traded would begin to equal the value of goods and services produced, not exceed it by a large multiplier (sometimes known as "leverage" but true gamblers know it as "odds"), as is now the case. Real money would chase real goods, and the manipulators would all be out of work and gone would be their ability to affect the markets we all have to play in, such as the oil market.

There have been stock exchanges for 500 years, and commodity exchanges for 400 years or so. There have only been "short sellers" in my lifetime and "spiders" in the last few years, and it's in my lifetime that the markets have become too complex. Criminals, manipulators and tax evaders have all enjoyed this shady marketplace, because the rules change on whims and no one can keep up with it.

If we dump the derivatives markets, honest investment capital will keep the real economy afloat, and even prosper it. The only losers will be the gamblers, people who care not a fig for actual production or sales or services rendered. We can do without them AND their plastic trillions.

What just happened in the Fed?

Someone correct me if I'm wrong, but it was announced overnight that the Federal Reserve Bank, which has a limited charter to act as a "superbank" between banks, not at the level of a European Central Bank, has just set up a subsidiary institution, funded with $900 Billion (taxpayer) dollars, to buy "commercial paper". In other words, this institution will compete with commercial banks which do exactly the same thing, but have reduced their transactions in such paper to a trickle due to the economic crisis.

The attitude of the new Fed "Paper Bank" will be, "Crisis, what crisis?".

Does anyone know where the legal authority came from to set up, fund and operate this new bank? No one on the Street will talk about THAT pesky little aspect.

In other news, is the USA just going to stand by and let the Russians BUY the nation of Iceland, ALWAYS a strategic asset because it sits on the sea lanes between the USA and Europe? Read Tom Clancy's "Red Storm Rising" to see just how strategic Iceland is to our and European interests.

The Cold War ended in OUR MINDS ONLY about 20 years ago, but it never ended in Vladimir Putin's mind, and Putin is President-for-life of Russia (OK, he added "emeritus" to that and has a stooge working for him now, but you get the idea). My children will live to see the Cold War "renewed", and maybe actually fought this time.

To the Russians, the current economic crisis is just another opportunity to destabilize the NATO alliance, and they are doing exactly that. Curious, because NO ONE would cash any check from Russia right now.

How do we save the tanking economy?

As the previous post might have mentioned, it was another bad day on the Street, with the Dow losing another 4%, to add to that amount lost last week. The Europeans lost double that on their indexes. The Asians lost a little more than we did.

So, now that the trading day is over, some ideas are being floated around to stem the hemorrhage of liquidity from the major financial institutions.

Everything from the sublime to the ridiculous.

Some suggest the sublime approach, that the Fed just keep lowering the rediscount rate, up to as much as a full 100 basis points (one full percent). In first aid terms, this is like putting a sieve on a sucking chest wound, when only an occlusive dressing will save the patient. Non starter. Lowering the rediscount rate works only when the banks HAVE cash to loan each other, and WANT to loan to each other. Neither of those preconditions are met at this point.

Then we get to the ridiculous. Suspend the banks' mark-to-market rules. To reconcile their books, banks are required to list the value of assets owned according to standard, acceptable market pricing of those assets. If that rule is suspended, the banks may put any price they choose on assets. If, for example, a tax accounting is due, they can price way low, say they took a loss, and pay no taxes. OTOH, if a bank examiner stops by and wants to see if they have enough capitalization on the books (reserves), they can list assets way high to satisfy the examiner. With no rules of what assets are actually worth, how will we ever again know what the fiscal health of the banking system is? This isn't free market, it's free-BOOTING marketing, or piracy.

This banking crisis is on us now because two years ago, banks got together and decided that they didn't need no steenking reserves, so they spent them all (on bad mortgage paper). Now that there's a crisis of confidence, they have no reserves, which deepens the crisis, so this suggestion of changing the accounting rules is just a smoke-and-mirrors trick to fool us into regaining our confidence and putting money back in the banks, who will promptly forget all the lessons, just like the Asian bankers did from their mini-crisis 10 years ago to their worse crisis of today.

Nope. Now that the crisis is on us, ride it out until bottom is found, probably around another 20% loss of total world capital. Rebuild from there. That's the only way to do it, for to start rebuilding on a false bottom will only speed the day when this will all happen again.

Do you believe in miracles?

If you believe that the many-Trillion-dollar banking industry, plagued as it is by holding paper of poor quality totaling as much as 6 Trillion, can be saved by application of $700 Billion dollars from the Treasury, you qualify as believing in miracles.

I don't believe in miracles, and it seems the news from Europe supports my lack of such belief. The Europeans control their banking systems very tightly through their Central banks, and if they are having a rash of bank failures similar to ours, well, I guess that the correct conclusion to draw is that this infectious banking disease has spread widely.

It ain't over by a long chalk, folks, so my previous advice still holds: remove yourself from your banking relationships as far as you can. For example, I still maintain funds on deposit at my credit union, which grants very few mortgages, and never granted or invested in any subprime ones, but I have stopped using the electronic bill-pay system to pay bills. I had funds in a failed bank also (WaMu), but withdrew them.

I am prepared to deal in cash through a bank holiday of several month's duration, and in other specie well past that.

This is NOT the time to let your guard down.

Who's upside-down now?

OK, you are a yuppie who recently bought a swank condo in the "renewal area" of your city. You're feeling good about yourself, but soon enough, your ARM mortgage topped out, and you can hardly make the payments on it and your Nissan ZX350 each month. You go to your friendly banker for help, completely unaware that his bank is ALSO upside-down.

Don't believe me? How about some stats from an insider. In the best tradition of Jeff Foxworthy, he writes "You know your banking system is unsound when:" and then lists 25 reasons.

It's a fine paper world out there, but there are damn few hard assets to back up all that paper. It now depends COMPLETELY on the "full faith and credit of the United States Treasury."

YOU may have "full faith and credit", but I don't. That's why I have gold as my ONLY investment.

H/T to Concerned American at Western Rifle Shooters

What will be fixed?

...with the Government bailout of Freddie Mac and Fannie Mae?

Let's look at the egregious faults of the present mortgage industry, and whether this "fix" will include any of them.

1. Loaning more than the actual market value of the residence. Probably will be fixed. The Feds have never done that, although they do accept some fairly inflated appraisals, and THAT has to stop. The housing market itself will have to be allowed to fully adjust downward to actual value for this to be fully effective, though.

2. Loaning to anyone who walks through the door. Won't be fixed, because it's oh so politically incorrect to refuse EVEN ONE person of color or tranny or whatever a loan. The dot.gov doesn't understand that work ethic, credit and employment history are the ONLY things to base the granting of a mortgage on, but they'd never write THAT in a contract.

3. Adjustable-rate loans. Will probably disappear. The Feds have always loaned fixed-rate, to my knowledge anyway.

4. "Locks". This feature of all new loans in the past 20 years or so gets the banks in trouble. A customer comes in, requests a loan, fills out a pre-application and gets "locked in" on a rate. This discourages the bank from looking critically at the application, since they've sort of agreed to grant it by extending the "lock" privilege. I think it will stay, but be modified into something that doesn't attach any grant privilege. It isn't really necessary for the Feds to have it, since their rates change much less often than does the commercial market.

5. Cash-out. Will probably disappear. The Feds haven't done that before, and shouldn't this time, although if Biden gets his fingers in this pie, being a shill for the "plastic" banks, he will try to put it in.

6. Automatic HELOCs. Homeowner lines of credit will end, at least as an automatic feature of new loans. The commercial banks have already closed most of the HELOCs to new drafts anyway.

Over-all, this picture looks good, if it all shakes out the way I've predicted. It should cure about 60-70 percent of what caused all the previous bad loans. If they fixed #2 above, they could cure it all, but that's not going to be fixed.

Then there's the pork factor. Since the dot.gov just wrote itself and the mortgage banking industry a blank check, there is no reason to expect that the Congress should behave any differently than in the past, and they'll load the program down with pork, not-so-little gifties to various folks who have or will make claim that the end of business for Mac and Mae has hurt them. The pork factor is unknown, and shouldn't hurt the operational fixes that the new program will bring about in the home loan industry, but it WILL cost a bunch, could easily add 30% to the cost of the program, which is already slated to cost $200BN and up.

"Irrational Exuberance", Part Deux

"Irrational exuberance" were the words of a former Federal Reserve chairman when he described the inflated condition of the equities markets relative to the real world some years ago.

So, finally admitting that the entire mortgage industry is in the tank, the Feds took over the two biggest mortgage banks which had, essentially, failed, leaving $5 TRILLION in mortgages unsupported by anything except the aforementioned irrational exuberance.

What does the stock market do on hearing this news?

Raise their martini glasses.

We don't deserve this great country, people. If our "economic leaders" think that the insolvent dot.gov taking over ANYTHING is a sign of stability, they're as cracked as the Liberty Bell.

My advice: Buy gold, not stocks. Buy ammo for your guns (and/or buy the guns if you haven't, you only have about 20 weeks left before some/all of them are un-buyable), and buy shovels.

Hey Buddy, can you spare $5 Trillion?

Imagine, if you will, a vagrant approaching you on the street and asking you, not for "spare change", but for five trillion dollars.

That is the un-enviable position of the US Treasury Dept right now. It's regulators have taken over Fannie Mae and Freddie Mac, the quasi-Governmental mortgage banks, because they are broke, their shares having fallen to about 8 percent of their recent value.

The loan portfolios of these two giants, which guarantee the security of about 60% of all US residential mortgages, amount to roughly $5,000,000,000,000, or about 40% of the entire Gross Domestic Product.

As I understand these two banks' operations, they don't actually HOLD the loans, they GUARANTEE them. There's a difference. If the loan defaults, as about 5% of them have, the commercial bank holding the paper may request that the guarantor make good on it. A guarantor is like a co-signer of the note. It is estimated that as many as 20% of these loans are in some threat of default, due to the practice of making many of them as Adjustable Rate Mortgages, loaning as much as 125% of the actual cash value of the property (remember all those awful Di-Tech ads on teevee?). As all those ARMs reach their maximum interest rate potential, many of the mortgagees can't make the payments. To that, add the fact that real estate values have fallen, as much as 30% in many markets, and could fall farther, and you have a prescription for many folks having to walk away from their homes, and give the properties back to the banks. The banks don't do well selling them, and rarely recover 50% of what they have loaned out, so they bang the US Treasury for the difference via the guarantee.

Enter Joe Biden, Democratic Veep nominee, and shill for the big banks. He was apparently interviewed on "Eat the Press" this morning, and made a couple of curiously conflicting statements (but when doesn't he).

In the AssPress synopsis (I don't watch Eat the Press), Biden tries to lead with what he must think is fiscal conservatism:

"Joe Biden says the government's rescue of the big mortgage companies Freddie Mac and Fannie Mae should not mean bailing out shareholders at the expense of taxpayers."

Excellent, I agree. but then his true colors show: again from AP:

"The goal is to shore up the mortgage market."

So how do you "shore up" the mortgage market without bailing out the commercial banks which hold the bad paper? The short answer is that you can't.

I smell another wealth transfer coming, but because investor-owned banks are involved, it will be out of the little guys' pockets, not the big investors. Biden and the (D)onks will find a way to raise taxes on the middle class and hand this money to the mortgage bankers who STUPIDLY loaned out money which financed the "plastic economy" that is failing as I write.

I say let the banks fail. We depend entirely too much on them in this culture, and they have led us, Pied Piper fashion, out of the good habit of squirreling actual money away as cash savings and into the never-never land of plastic money, an invention of their own that they control and get their vig off of. Yep, there will be hard times when they go under, the banks will see to that, but when we survive (and the smartest and strongest of us will come out of it faster), we will have learned a valuable lesson about plastic money and phony real estate valuations.