Economic Crisis
So how did this financial mess get started? I'm going to start with an email that I wrote to a friend of mine upon figuring out that the median income household in 2006 could not afford a median priced home at the time without severely going into debt. I wrote this email in April of 2008:
"With all the talk about the sub-prime crisis driving our economy into a recession have you ever heard ANYONE in the media talk about any of the underlying causes. I decided to try to make sense of all this myself. Check this out:
| Median Household Income 2006 | $48,201.00 |
| Median Montly Income | $4,016.75 |
| Median Home Value | $217,900.00 |
| Total Cash Flow Out | $3,936.14 |
| Total Cash Flow In | $3,213.40 |
| Net Cash Flow | ($722.74) |
Click here to see the spreadsheet behind the analysis.
*I used very conservative expenses and liberal home mortgage guidelines. Scenario is for a family using 10% down and no second mortgage.
*No car payments and minimal health care costs were considered in the "Total Cash Flow Out" figure
What all this means is that a median income family with very low monthly living expenses who has a mortgage on a median priced home (based on 2006 pre-crisis figures and guidelines) will be in the hole each and every month $722.74. Why is nobody addressing this? Why has nobody brought it up? The media would rather slam the home mortgage industry and borrowers with bad credit instead of doing some real journalism to investigate the underlying causes. The fact of the matter is that without home equity borrowing and heavy credit card debt the median income family CANNOT survive.
Economist and Shadowstats founder Jon Williams summed up the cause of the crisis brilliantly:- Why is something so simple being overlooked?
- Who benefits from this being overlooked?
- Why is it that 25 years ago an uneducated wage earner own a home, 2 cars, and support a family without going heavily into debt and now that is impossible
- Is this not a form of indentured servitude?
Here are some issues contributing to this trend
Globalization -
- High paying manufacturing jobs are moving overseas (Mexico thanks to NAFTA and China thanks to the WTO)
- Free trade allows the US to flood foreign markets with subsidized agricultural goods forcing the rural populations of poor countries to find work in the urban areas where multi national corporations can exploit them in order to lower costs of production. This is why Wall Mart has such low prices.
- With the manufacturing jobs fading away the remaining labor pool must come up with new ways to make a living which increases competition in the service sector (ex: the real estate market boom in CA)
Costs of housing
- The same boom that has created so many jobs via the real estate market is also creating a crisis in the form of giant housing expenses. Without being able to cash out home equity families can no longer keep up with their increasing living expenses
Oil
- Peak oil is real. There is only so much to go around and a lot of analysts believe that we have used half of the oil in existence already. Thanks to China and India's booming economies, demand for oil will increase over the long term. The price of oil affects everything. All goods must be transported at some point. This is a direct cause of inflation. Oil's rapidly increasing demand is partly due to globalization...(notice how all these issues are inter-linked?).
Inflation
- Don't believe the CPI index or any of the inflation #'s you get from the media. The CPI is fabricated in order to make the dollar appear stronger than it actually is. They use what's called "natural substitutions" to get their figures. For example, let’s say (hypothetically) that the Fed wants to figure out what the inflation rate is using Filet Mignon as their indicator. When they compare the price of Filet Mignon 25 years ago to the price of a Filet Mignon today they see that the price has inflated at an annual rate of 12%. Instead of coming out and saying that inflation is 12%, the Fed will use a “natural substitution". Their logic is that it’s not fair to compare the price of a Filet Mignon 25 years ago to the price of a Filet Mignon today because somewhere along the line the average person would substitute a cheaper form of meat for the Filet Mignon since it became too expensive. The Fed will then compare the price of a Filet Mignon 25 years ago to the price of a London Broil today and extrapolate the inflation rate from this comparison. Since the price of a London Broil today is significantly less than the price of a Filet Mignon today, the inflation rate will appear to be much lower than it actually is. In this case it will be something like 3% per year. This is an obvious fabrication, but it is what the Federal Reserve passes off as the truth.
- Thanks to fractional reserve banking all money is created out of debt. Every time someone borrows money from a Fed member bank, the money supply increases which generally increases inflation.
- Watch this whole series to get a grasp of the basics of our monetary system Money as Debt. Henry ford said that "if the population [spontaneously] understood how our monetary systems works then I fear there would be revolution by tomorrow morning". Don't forget that almost every country on earth now uses a fractional reserve monetary system
War
- The government has been running in the red for a while now thanks in part to our perpetual war on terrorism. George W. Bush has ran up a deficit larger than ALL past presidents COMBINED. Obama is doing the same. Where does the money for the perpetual war on terrorism come from? 2 places; out of nothing via the federal reserve, and from creditor countries (China being the largest). Ultimately all dollars are created by the federal reserve, so even the dollars that China is holding in reserve were at one point created out of nothing via the fractional reserve banking system.
Trade Deficit
- The United States runs a huge trade deficit...the largest being with China. We will use China as our trading partner in the following example. We buy Chinese products using dollars. Thanks to our arrangement with OPEC via Saudi Arabia, all oil is bought and sold in US dollars. This arrangement forces foreign countries to hold large reserves of these dollars. China and other countries with large dollar reserves loan the money back to us. This expands credit domestically and keeps our economy going so that we can continue buying crap that we don't need by going heavily into debt. If those dollars were to all be sold and flood the currency market in a giant sell-off then the U.S.A. would be abruptly destroyed.
- Here's what countries have started to do with their excess $'s: http://news.bbc.co.uk/2/hi/programmes/newsnight/7254692.stm
As you can see these are some very deep interlocking issues that nobody in the mainstream media has addressed. These are just the basic problems. Who benefits from all this? Obviously it's not the average American. It's not the working class foreigners who now have to try to scrape up a living in slave labor conditions. The inequality in the distribution of income has increased in all countries since the rise of globalization. Only the rich are benefiting. This deterioration applies not just here in the U.S., but world wide. Remember, there are poor people in rich countries and rich people in poor countries.
This trend is no accident. Modern globalization and fractional reserve banking will eventually reduce the working class to indentured servants without the average person ever becoming aware of it. Those who benefit from income inequality would like nothing better than for us to absorb whatever misinformation is fed to us through the media and never ask any deeper questions. They are getting their wish. People are more concerned over whether or not Obama wears a flag pin vs. how he plans on saving the dollar. Are you kidding me? Are we as a population so dumbed down that we are incapable of asking the deeper questions let alone start looking for answers? I don't believe it. I think that we are just tired from working so hard and so worn down from the stress of financial insecurity that our wills have been somewhat broken. It's not a lack of intelligence or passion. It's a lack of energy. It's also the fact that we feel like there's not much we can do about it. What we can do is talk about it and educate each other. The only way that things will change is if everyone understands what is happening. This change has to come from the bottom up. It will never happen from the top down. Tesla said that the only way the human species will ever survive is through spontaneous universal enlightenment.
Bringing these problems up does not make us pessimists. If you were a pessimist you wouldn't bother talking about any of this. Acknowledging problems is the first step toward finding solutions. If you or I thought that this was all hopeless then why would we bother talking about it? You have to believe that humans are capable of more than this system that is in place right now. God gave us all consciousness, intelligence, and free will. Given that, I think it's obvious that we as a species are capable of pursuing a higher path than the one of self-destruction that we are pursuing now. Think about it...if your entire global system of economics and politcs are based on the market forces of fear and greed, then isn't the species doomed to failure right off the bat.
---What do you think?
"As discussed in recent writings, the economy suffers from underlying structural problems tied to consumer income, where households cannot keep up with inflation and no longer can rely on excessive debt expansion for meeting short-falls in maintaining living standards. The structural issues are not being addressed meaningfully and cannot be addressed without a significant shift in government economic and trade policies, which under the best of circumstances still would drag out economic woes for many years.
The current depression likely will show multiple dips in business activity, as was seen during the Great Depression and in the double-dip recession of the early-1980s. I shall argue that the current downturn started at least a year earlier than the December 2007 onset proclaimed by the National Bureau of Economic Research (NBER), official arbiter of U.S. recessions. The current depression is the second dip in a multiple-dip downturn that started back in 1999, and it preceded and in fact was the proximal trigger for the systemic solvency crisis that rose to public view in August 2007. The ensuing systemic problems did not cause the slowdown in business activity, but they exacerbated it significantly." - Jon Williams, Depression Special Report, August 1st, 2009.
As you can see from the graph above, when properly adjusting GDP for inflation, the US economy has been in recession since 2000 (except for a brief period of minimal growth in 2004).
Here's what the real inflation rate is (Taking out the substitutions methods used in the gov't #'s):
So, you see that it was the inflation that caused the defaults in 2007 which initiated this most recent financial crisis. Real inflation was close to 15% by late 2007. That's roughly equivalent to the high inflation rates we had back in the late 70's and early 80's. Mr. Williams describes how gov't statistics are manipulated in Shadowstat's August 2006 Newsletter:
"Some years back, then Fed Chairman Alan Greenspan began making public noises about how the CPI overstated inflation. Where the fixed-basket of goods approach would measure the cost of steak, year after year, Mr. Greenspan argued that if steak went up in price, people would buy more hamburger meat, mitigating the increase in their cost of living. The fact that switching the CPI concept to a substitution-based basket of market goods from a fixed-basket violated the original intent, purpose and concept of the CPI, never seemed to be a concern to those in Washington. Artificially reducing reported CPI inflation would have a variety of benefits, beginning with reduction of the budget deficit due to the cutting of cost-of-living adjustments for Social Security payments. Accordingly, geometric weighting was introduced to the CPI reporting methodology, which had the effect of mimicking a substitution basis. Since the revised CPI still did not show as low an inflation rate as a fully substitution-based index would, Mr. Greenspan began focusing the Fed's inflation targeting and measurement on the inflation rate used to deflate personal consumption expenditure (PCE) in the GDP. Such was a substitution-based measure."
In case there was any doubt about how our GDP growth had been accomplished over the past few decades, please see the chart below:
This graph is telling us that GDP growth over the past few decades has been a completely debt fueled ride requiring exponentially increasing amounts of public and private debt in order to maintain linear GDP growth. This is clearly unsustainable.
How CDO's Work (Financial Weapons of Mass Destruction)
The pooling of loans described in the clip above is a basic form of hiding risk. What CNBC chooses not to talk about is the role that ratings agencies have played in this fraud and how large commercial banks and Wall Street firms have used these instruments to employ massive amounts of leverage while making huge commissions on each transaction performed. It is important to keep in mind that the bonds which were backed by these debt pools would have been worthless if they were not rated by the large ratings agencies (Moody's, S&P, Fitch, ect.) using overly optimistic models. These ratings agencies were paid by the very same firms who were issuing the bonds. Can you say "Conflict of Interest"? Between 2002 and 2006, Moody's doubled their revenue and nearly tripled their stock price during the frenzy. Think these firms might have been in bed together?
Another issue that CNBC chooses not to talk about is the fact that the models used by the mathematicians to evaluate the value of the CDO's and the bonds were so complicated that very few individuals understood them. One of the primary assumptions of all these models was that home prices would go up forever.
Charles Morris in his book The Trillion Dollar Meltdown" says
"In almost all cases, a trust, or special-purpose entity (SPE), technically independent of the parent, would be created to purchase the assets. The purchase would be financed by selling securitized paper, usually with a tranched structure to broaden investor appeal. For banks, selling assets and liabilities off their balance sheets reduces strain on regulatory capital; for companies, it lowers apparent debt.
The complexity of the instruments spiraled into absurdity. In 1983, modeling the payout scenarios on Fink's comparatively simple three-tranche CMO took a mainframe computer a whole weekend. But by the 1990s, when Sun workstations were standard furniture, CMO shops gleefully spewed out phantasmagorical 125-tranche instruments that no one could possibly understand. No matter how clever the structuring, however, a CMO was still a closed system: All the tranches drew their payouts from the same pool of mortgages. The more you tweaked a higher-rated tranche, the more violent the impact on the low-rated slivers at the bottom of the pile, or the "toxic waste," as it was known. Disposing of the toxic waste soon became the primary limit on growth. Firms could carry some on their own balance sheets, and more could be fobbed off on innocents like newly wealth Indian tribes and doctors' retirement funds"
What this means is that banks were selling these toxic assets to special purpose entities which were owned in part by the very same banks selling them the assets. Once these assets were off their books the bank or financial institution could start the process all over again. This scheme allowed banks to use unlimited leverage. Financial institutions used these special purpose entities in much the same way as Enron used shell companies in their epic scheme...only the banks did it on a much larger scale.
The fact that nobody understood the models used to valuate the bonds which were backed by the CDO's only added fuel to the fire. Ratings agencies would base their ratings on whatever outputs the models gave them, even though they had no idea what variables were being considered in the model's algorithms. How could they rate something they didn't understand? The buyers of the bonds certainly didn't understand the models either, but they bought anyway based on the rating. Are you starting to understand the fraud that went on here?
This NY Times article from April 27, 2008 does an excellent job of explaining how these pools of mortgages work and how they are rated.
"The challenge to investment banks is to design securities that just meet the rating agencies’ tests. Risky mortgages serve their purpose; since the interest rate on them is higher, more money comes into the pool and is available for paying bond interest. But if the mortgages are too risky, Moody’s will object. Banks are adroit at working the system, and pools like Subprime XYZ are intentionally designed to include a layer of Baa bonds, or those just over the border. “Every agency has a model available to bankers that allows them to run the numbers until they get something they like and send it in for a rating,” a former Moody’s expert in securitization says. In other words, banks were gaming the system; according to Chris Flanagan, the subprime analyst at JPMorgan, “Gaming is the whole thing.”
"The agencies do not deny that a conflict exists, but they assert that they are keen to the dangers and minimize them."
"Poring over the data, Moody’s discovered that the size of people’s first mortgages was no longer a good predictor of whether they would default; rather, it was the size of their first and second loans — that is, their total debt — combined. This was rather intuitive; Moody’s simply hadn’t reckoned on it. Similarly, credit scores, long a mainstay of its analyses, had not proved to be a “strong predictor” of defaults this time. Translation: even people with good credit scores were defaulting. Amy Tobey, leader of the team that monitored XYZ, told me, “It seems there was a shift in mentality; people are treating homes as investment assets.” Indeed. And homeowners without equity were making what economists call a rational choice; they were abandoning properties rather than make payments on them. Homeowners’ equity had never been as high as believed because appraisals had been inflated."
-DUH!
This Wall Street Journal article states that the ratings agencies did indeed make the assumption that home prices would go up forever:
"The rating agencies understated the risks from these bundled mortgages by assuming that home prices were simply going to rise forever."
Charles Morris in his book The Trillion Dollar Meltdown says exactly the same thing and in his Foreign Policy article says:
"Pension funds cannot generally invest in very risky paper as a mainstream asset class. So, banks and investment banks, with the acquiescence of the ratings agencies, create “structured” bonds with an illusion of safety. Eighty million dollars of “senior” CDO bonds backed by a $100 million pool of subprime mortgages will not incur losses until the defaults in the pool exceed 20 percent. The ratings agencies confer triple-A ratings on such bonds; investors assume they are equivalent to default-proof U.S. Treasury bonds or blue-chip corporates. To their shock, investors around the world discover that as pool defaults start rising, their senior CDO bonds rapidly lose trading value long before they suffer actual defaults."
In this article written by Yves Smith on the Naked Capitalism blog (an excellent resource) on November 10, 2007, Yves says:
"As readers probably know all too well, CDOs had been valued using models that the rating agencies had developed solely for credit rating purposes. Investors had carried CDOs on their books at more that they were probably worth, at first out of ignorance, because they didn’t realize the subprime paper they held was weaker than it had been historically, and later out of convenience (why recognize losses if you don’t have to and no one else seems to be doing so either?). And the investment banks were similarly able, in the absence of price discovery, to carry the CDOs on their books (they wound up owning them by not being able to sell out the full amount they created) without marking them down too much."
This was written before the mark-to-market rules of accounting were repealed. For example; if XYZ Investment Bank is holding $1B worth of mortgage backed securities (bonds backed by CDO's), and the market value of those bonds drop to $600M because the risk of default has greatly increased (due to borrowers defaulting on their mortgages), then XYZ Investment Bank would have to write down the value of their bonds by $400M. After all, they aren't holding $1B worth of bonds...they are holding $600M worth of bonds. This creates transparency for regulators, creditors, and investors who are concerned with the institution's financial condition. When subprime mortgages started defaulting at an increasing rate in 2007, financial institutions were forced to write down their assets because the market value of these derivative securities were plunging as the risk of home mortgage borrowers defaulting increased. This caused the banks to tighten up their lending standards making it more difficult for borrowers to refinance which lead to more foreclosures which lead to more write-downs causing home values to decline leading to even tighter credit, more foreclosures, and more write-downs. This is called reflexivity and is analogous to a downward spiral.
In a traditional recession, asset prices would drop until they became affordable again. Investors would start buying once the bad debts had been cleared off the books of financial institutions. People would start buying real estate once the prices of houses came down enough to where they could afford them. This is what usually happens once a bubble bursts. Asset prices return to equilibrium and the economy recovers.
A normal recovery was not an option this time because the derivatives market is so large that the write downs would destroy the financial system of the entire world. How this is possible is explained below in the credit default swap clips.
Credit Default Swaps
This video was recorded shortly after the treasury took over Freddie Mac and Fannie Mae thus nationalizing about half of the secondary mortgage market. At about 3 minutes in our Brit is going to start explaining what credit default swaps are and how they work.
The key point made in the video above is that you don't have to own the underlying asset that you wish to insure.That's how this market got so huge. Multiple parties could take out insurance on assets that they didn't own.
A common misconception is that only insurance companies issued credit default swaps. The fact of the matter is that investment banks, hedge funds, and speculators all sell protection. They don't even have to prove that they have the money to cover the asset in the event of a default. In the larger view of this market, it is impossible for these institutions to have enough money to cover all the insured assets that they have agreed to cover since there is more insurance than there is money in existence. If all the insured assets defaulted, there is not enough money in the world to cover those losses!
Credit default swaps are not the only type of derivative with the potential to destroy the world financial system.
Here's what derivatives had to do with the JP Morgan takeover of Bear Stearns:
http://georgewashington2.blogspot.com/2008/06/derivatives-market-is-unwinding.html
Here's what derivatives had to do with Fannie and Freddie:
http://www.webofdebt.com/articles/its_the_derivatives.php
Banks want the derivatives market to remain opaque:
http://www.globalresearch.ca/index.php?context=va&aid=9202
Banks hidden junk:
http://bloomberg.com/apps/news?pid=newsarchive&sid=akv_p6LBNIdw
Credit default swaps are one of the primary reasons banks and investors were able to use so much leverage and hide risk at the same time. According to Charles Morris in "The Two Trillion Dollar Meltdown":
"And just in 1987, the availability of credit insurance let investors climb higher and higher up the risk curve. Lulled by the presence of credit insurance, investors who might have been wary of the lowest rated CLO's and CDO's snapped them up for their extra risk yields. And why not? The mathemeticians had banished risk.
When money is free, and lending is costless and riskless, the rational lender will keep lending until there is no one left to lend to. Alan Greenspan foresaw a glorious new era of finance. Adding to his string of memorable bubble endorsements, he announced "a new paradigm of active credit management"
Here is the Bank for International Settlements 2007 report on derivatives. 2007 was the peak of the derivatives market. This covers the entire derivatives market and provides statistics on how many of these derivatives are out there.
http://www.bis.org/publ/otc_hy0711.pdf?noframes=1
$700 Billion is Nothing
Our entire economy is a house of cards and has been for some time. The leverage and hidden risk employed by Wall Street gave the illusion of prosperity for a short amount of time. Now that these markets have started to unwind, the powers that be are left with no other choice but to try to kick these problems under the rug and hope that nobody notices. The way this is accomplished is through "Mark to Model" accounting.
The only way to prevent the inevitable was to repeal the mark-to-market rule described above and let the banks keep these assets on their books at whatever valuations they came up with in the original overly-optimistic models. This is called mark-to-model accounting.
http://www.bloomberg.com/apps/news?pid=20601087&sid=agfrKseJ94jc
The use of this accounting rule allows banks to pretend to be solvent. They are no longer required to take any more write-downs. In fact, they were able to write-up the assets that they had written down before the rule change. This made it look as though the banks had recovered even though their financial condition had not changed. The problem with this fraudulent accounting is that it prevents a return to equilibrium. They are just kicking the can down the road. Remember that this whole mess started because asset prices were too high for the average consumer to be able to afford their debt payments. Home prices were too high, gas prices were to high, medical costs were too high. This stress is what helped cause the original defaults that set off the sub-prime crisis in 2007. Peter Schiff explains this whole process very clearly in the clips below.
The Philosopher's Stone (Peter Schiff and Ron Paul)
I think it's time that we start listening to the people who have a track record of being correct. Peter Schiff was warning the public about the impending real estate collapse long before it happened.
Please check out Peter Schiff's website at Europac.net. Peter and his team comb the internet every day looking for stories that they feel have been largely overlooked by the mainstream media.
Below I have posted several clips of Peter Schiff addressing a group of mortgage bankers prior to the sub-prime meltdown. At the time it was extremely unpopular to say anything pessimistic about real estate and it took a lot of courage for Mr. Schiff to appear at this meeting and speak so candidly about what he felt was an inevitable collapse.
He describes very clearly and precisely the steps that the US had taken to weaken its economy and goes on to prophetically describe the consequences of these actions.
Peter Schiff Mortgage Bankers Meeting 11/13/06
In the clip above, Peter hits the nail on the head at abour 4 minutes in when he says that we should have had a much deeper recession in 2002. Instead of letting that recession run it's course we tried to fight it using inflation. This observation is entirely consistent with the chart provided by Jon Williams from shadowstats:
GDP started climbing back up when the inflation created by the federal reserve kicked in. We returned to positive growth for only one quarter in 2003 and even then it was barely above zero. That signal that was misinterpreted by the markets. Investors thought the economy was in a boom when in fact it wasn't growing at all when adjusted for inflation.
At about 2:30 in the above clip Peter talks about how government statistics are manipulated. He goes into great detail about these statistics in his book "Crash Proof". What he says is also backed up by Jon Williams of Shadowstats, Kevein Phillips in "Bad Money", Charles Morris in "The Two Trillion Dollar Meltdown", by Ellen Brown in "Web of Debt" , and virtually every economist who is not sponsored by the fed or a government agency. Why aren't private economists screaming about this fraud every second of every day? Here's why:
http://www.nakedcapitalism.com/2009/09/why-economists-rarely-saw-bad-things-about-the-fed.htmlgs-about-the-fed.html
I know that the above article is talking about the fed in general, but the concept is the same. The Federal Reserve backs the statistics published by the US government. To deny these statistics is to deny any analysis that the Federal Reserve publishes. That is why the above article is very relevant to the statistics issue.
At about 3 minutes into the clip below, Peter's opponent starts attacking the messenger instead of the message. That usually happens when the debater has absolutely nothing left to stand on forcing them to resort to lowbrow tactics (the audience laughs at the guy when he purposely gets the name of Peter Schiff's firm wrong).
Why the Financial Meltdown Should Have Surprised No One
Here is another lecture by Peter Schiff to a group of Austrian Economists. This took place after the meltdown.
12-6-08 Bailout Cost = $8.5T
The Real Scoop on Unemployment
Karl Denninger Commentary on the Banks (9/3/09)
As Denninger (Market-Ticker) very clearly points out, all of our major banks are insolvent as of right now. Since mark to market accounting has been repealed, we never get to see a realistic picture of what a bank's assets are worth until they are seized by the FDIC and the assets are sold in the open market. When this happens we have found that the assets on the seized bank's books were overvalued by up to 40% and no less than 10%. If this is the typical overvaluation of banks' assets, then the entire financial industry is technically insolvent and has been for quite some time.
Colonial Bank's assets were overvaulued by 37% when they were seized:
http://market-ticker.org/archives/1391-Diversions-To-The-Special-Continue.html
As we have seen, most bank assets are covered by credit default swaps. There are enough of these swaps out there to completely wipe out the entire money supply of the planet. The system as a whole is technically insolvent.
I would also like to point out that FASB (Federal Accounting Standards Board) was being pressured to change the mark-to-market accounting rules since October of 2008 (http://www.webeatthestreet.com/index.php?id=572) and repealed mark-to-market on April 2, 2009. Here's how the market has reacted since the new rules were officially adopted:
This is the chart for the Dow Jones Industrial Average for the period 4/2/09 - 10/31/09
The stock market has more than applauded this move to kick all our problems under the rug. Savvy investors know that this move only postponed the inevitable. These investors are certainly going to try to scientifically time their exit.
Black Swan - Chaos Theory (this is a little more esoteric, but hints at the root causes of financial turmoil)
Trends Forecaster Gerald Celente on What to Expect in the Near Future
Jon Williams of Shadowstats.com on Money Supply
The reason why this huge increase in M3 money supply hasn't kept the high rates of inflation going in the year 2009, is because of something called the velocity of money. The Fed did create unprecedented amounts of currency in this financial crisis, but it hasn't showed up in asset prices because that money has not hit the spending stream.
In order for inflation to occur, money must be loaned out to consumers and businesses who will use these funds to buy "things". Remember, the money that the federal reserve creates from thin air is a small fraction of the total money supply once the newly created federal reserve money makes its way through the banking system (see the Money As Debt blog). The faster the money is lent out, the greater the inflation. In normal economic times, the money that the fed prints will multiply at least 10 times over once it makes it's way through the banking system. For example...if the fed created $1B dollars, the end result would be an increase in the M3 money supply of $10B dollars. In the current economic crisis the fed has printed up trillions of dollars that have not even started to make their way through the banking system. Imagine what would happen if the banks opened up their lending standards to pre-2007 levels. The result would be catastrophic inflation because M3 would increase 10 fold or more depending on how fast the trillions printed up by the fed make their way through the banking system. Money has a tendency not to stand still and the trillions I am speaking about have already been created by the fed. The question is...how long will it take for these trillions to make their way through the banking system? If the fed were to try to soak up some of this liquidity before the inevitable inflation picks up speed, the affect on the economy would be catastrophic. Without the ability to borrow money, there is no illusion of economic health, and the house of cards comes tumbling down.
Here's what's happening now...The Dollar Carry Trade:
Recent articles:
Recent Bloomberg article about toxic loans on banks’ books:Here’s what’s happening with mortgages as of 8-20-09 (13.16% of all mortgages are 30+ days behind. Cure rates have dropped from 40 % down to 6%):gger and better fashion than anything Enron could have ever dreamed of):The next wave of foreclosures (2nd wave worse than the first and it’s not subprime that’s the problem this time):Commercial Real Estate (tick tock...tick tock…tick tock)
Here’s what’s coming (SIV’s are similar to the shell companies that Enron had set up in their epic scam. Banks used the same concept, but in a bi
(Even the Atlanta Federal Reserve Chief agrees that unemployment is much higher than reported)Derivatives Breakdown (Here’s what the banks are holding on their balance sheets. This doesn’t include what they may be holding in SIV’s. SIV’s were addressed in a Bloomberg article above):Wanna know why booms and busts happen at all? (There are multiple parts to each series. If you have a short attention span then don’t bother):
We’re All Madoff (Nuff said. It’s the American way …or… er… uh… maybe not anymore)
So, you see that it was the inflation that caused the defaults in 2007 which initiated this most recent financial crisis. Real inflation was close to 15% by late 2007. That's roughly equivalent to the high inflation rates we had back in the late 70's and early 80's. Mr. Williams describes how gov't statistics are manipulated in Shadowstat's August 2006 Newsletter:
"Some years back, then Fed Chairman Alan Greenspan began making public noises about how the CPI overstated inflation. Where the fixed-basket of goods approach would measure the cost of steak, year after year, Mr. Greenspan argued that if steak went up in price, people would buy more hamburger meat, mitigating the increase in their cost of living. The fact that switching the CPI concept to a substitution-based basket of market goods from a fixed-basket violated the original intent, purpose and concept of the CPI, never seemed to be a concern to those in Washington. Artificially reducing reported CPI inflation would have a variety of benefits, beginning with reduction of the budget deficit due to the cutting of cost-of-living adjustments for Social Security payments. Accordingly, geometric weighting was introduced to the CPI reporting methodology, which had the effect of mimicking a substitution basis. Since the revised CPI still did not show as low an inflation rate as a fully substitution-based index would, Mr. Greenspan began focusing the Fed's inflation targeting and measurement on the inflation rate used to deflate personal consumption expenditure (PCE) in the GDP. Such was a substitution-based measure."
In case there was any doubt about how our GDP growth had been accomplished over the past few decades, please see the chart below:
This graph is telling us that GDP growth over the past few decades has been a completely debt fueled ride requiring exponentially increasing amounts of public and private debt in order to maintain linear GDP growth. This is clearly unsustainable.
Here is the consequence of debt fueled growth:
In terms of 1982 dollars, real wages have consistently gone down 66% since the mid 1970's (when properly adjusted for inflation).
How CDO's Work (Financial Weapons of Mass Destruction)
The pooling of loans described in the clip above is a basic form of hiding risk. What CNBC chooses not to talk about is the role that ratings agencies have played in this fraud and how large commercial banks and Wall Street firms have used these instruments to employ massive amounts of leverage while making huge commissions on each transaction performed. It is important to keep in mind that the bonds which were backed by these debt pools would have been worthless if they were not rated by the large ratings agencies (Moody's, S&P, Fitch, ect.) using overly optimistic models. These ratings agencies were paid by the very same firms who were issuing the bonds. Can you say "Conflict of Interest"? Between 2002 and 2006, Moody's doubled their revenue and nearly tripled their stock price during the frenzy. Think these firms might have been in bed together?
Another issue that CNBC chooses not to talk about is the fact that the models used by the mathematicians to evaluate the value of the CDO's and the bonds were so complicated that very few individuals understood them. One of the primary assumptions of all these models was that home prices would go up forever.
Charles Morris in his book The Trillion Dollar Meltdown" says
"In almost all cases, a trust, or special-purpose entity (SPE), technically independent of the parent, would be created to purchase the assets. The purchase would be financed by selling securitized paper, usually with a tranched structure to broaden investor appeal. For banks, selling assets and liabilities off their balance sheets reduces strain on regulatory capital; for companies, it lowers apparent debt.
The complexity of the instruments spiraled into absurdity. In 1983, modeling the payout scenarios on Fink's comparatively simple three-tranche CMO took a mainframe computer a whole weekend. But by the 1990s, when Sun workstations were standard furniture, CMO shops gleefully spewed out phantasmagorical 125-tranche instruments that no one could possibly understand. No matter how clever the structuring, however, a CMO was still a closed system: All the tranches drew their payouts from the same pool of mortgages. The more you tweaked a higher-rated tranche, the more violent the impact on the low-rated slivers at the bottom of the pile, or the "toxic waste," as it was known. Disposing of the toxic waste soon became the primary limit on growth. Firms could carry some on their own balance sheets, and more could be fobbed off on innocents like newly wealth Indian tribes and doctors' retirement funds"
What this means is that banks were selling these toxic assets to special purpose entities which were owned in part by the very same banks selling them the assets. Once these assets were off their books the bank or financial institution could start the process all over again. This scheme allowed banks to use unlimited leverage. Financial institutions used these special purpose entities in much the same way as Enron used shell companies in their epic scheme...only the banks did it on a much larger scale.
The fact that nobody understood the models used to valuate the bonds which were backed by the CDO's only added fuel to the fire. Ratings agencies would base their ratings on whatever outputs the models gave them, even though they had no idea what variables were being considered in the model's algorithms. How could they rate something they didn't understand? The buyers of the bonds certainly didn't understand the models either, but they bought anyway based on the rating. Are you starting to understand the fraud that went on here?
This NY Times article from April 27, 2008 does an excellent job of explaining how these pools of mortgages work and how they are rated.
"The challenge to investment banks is to design securities that just meet the rating agencies’ tests. Risky mortgages serve their purpose; since the interest rate on them is higher, more money comes into the pool and is available for paying bond interest. But if the mortgages are too risky, Moody’s will object. Banks are adroit at working the system, and pools like Subprime XYZ are intentionally designed to include a layer of Baa bonds, or those just over the border. “Every agency has a model available to bankers that allows them to run the numbers until they get something they like and send it in for a rating,” a former Moody’s expert in securitization says. In other words, banks were gaming the system; according to Chris Flanagan, the subprime analyst at JPMorgan, “Gaming is the whole thing.”
"The agencies do not deny that a conflict exists, but they assert that they are keen to the dangers and minimize them."
"Poring over the data, Moody’s discovered that the size of people’s first mortgages was no longer a good predictor of whether they would default; rather, it was the size of their first and second loans — that is, their total debt — combined. This was rather intuitive; Moody’s simply hadn’t reckoned on it. Similarly, credit scores, long a mainstay of its analyses, had not proved to be a “strong predictor” of defaults this time. Translation: even people with good credit scores were defaulting. Amy Tobey, leader of the team that monitored XYZ, told me, “It seems there was a shift in mentality; people are treating homes as investment assets.” Indeed. And homeowners without equity were making what economists call a rational choice; they were abandoning properties rather than make payments on them. Homeowners’ equity had never been as high as believed because appraisals had been inflated."
-DUH!
This Wall Street Journal article states that the ratings agencies did indeed make the assumption that home prices would go up forever:
"The rating agencies understated the risks from these bundled mortgages by assuming that home prices were simply going to rise forever."
Charles Morris in his book The Trillion Dollar Meltdown says exactly the same thing and in his Foreign Policy article says:
"Pension funds cannot generally invest in very risky paper as a mainstream asset class. So, banks and investment banks, with the acquiescence of the ratings agencies, create “structured” bonds with an illusion of safety. Eighty million dollars of “senior” CDO bonds backed by a $100 million pool of subprime mortgages will not incur losses until the defaults in the pool exceed 20 percent. The ratings agencies confer triple-A ratings on such bonds; investors assume they are equivalent to default-proof U.S. Treasury bonds or blue-chip corporates. To their shock, investors around the world discover that as pool defaults start rising, their senior CDO bonds rapidly lose trading value long before they suffer actual defaults."
In this article written by Yves Smith on the Naked Capitalism blog (an excellent resource) on November 10, 2007, Yves says:
"As readers probably know all too well, CDOs had been valued using models that the rating agencies had developed solely for credit rating purposes. Investors had carried CDOs on their books at more that they were probably worth, at first out of ignorance, because they didn’t realize the subprime paper they held was weaker than it had been historically, and later out of convenience (why recognize losses if you don’t have to and no one else seems to be doing so either?). And the investment banks were similarly able, in the absence of price discovery, to carry the CDOs on their books (they wound up owning them by not being able to sell out the full amount they created) without marking them down too much."
This was written before the mark-to-market rules of accounting were repealed. For example; if XYZ Investment Bank is holding $1B worth of mortgage backed securities (bonds backed by CDO's), and the market value of those bonds drop to $600M because the risk of default has greatly increased (due to borrowers defaulting on their mortgages), then XYZ Investment Bank would have to write down the value of their bonds by $400M. After all, they aren't holding $1B worth of bonds...they are holding $600M worth of bonds. This creates transparency for regulators, creditors, and investors who are concerned with the institution's financial condition. When subprime mortgages started defaulting at an increasing rate in 2007, financial institutions were forced to write down their assets because the market value of these derivative securities were plunging as the risk of home mortgage borrowers defaulting increased. This caused the banks to tighten up their lending standards making it more difficult for borrowers to refinance which lead to more foreclosures which lead to more write-downs causing home values to decline leading to even tighter credit, more foreclosures, and more write-downs. This is called reflexivity and is analogous to a downward spiral.
In a traditional recession, asset prices would drop until they became affordable again. Investors would start buying once the bad debts had been cleared off the books of financial institutions. People would start buying real estate once the prices of houses came down enough to where they could afford them. This is what usually happens once a bubble bursts. Asset prices return to equilibrium and the economy recovers.
A normal recovery was not an option this time because the derivatives market is so large that the write downs would destroy the financial system of the entire world. How this is possible is explained below in the credit default swap clips.
Credit Default Swaps
This video was recorded shortly after the treasury took over Freddie Mac and Fannie Mae thus nationalizing about half of the secondary mortgage market. At about 3 minutes in our Brit is going to start explaining what credit default swaps are and how they work.
The key point made in the video above is that you don't have to own the underlying asset that you wish to insure.That's how this market got so huge. Multiple parties could take out insurance on assets that they didn't own.
A common misconception is that only insurance companies issued credit default swaps. The fact of the matter is that investment banks, hedge funds, and speculators all sell protection. They don't even have to prove that they have the money to cover the asset in the event of a default. In the larger view of this market, it is impossible for these institutions to have enough money to cover all the insured assets that they have agreed to cover since there is more insurance than there is money in existence. If all the insured assets defaulted, there is not enough money in the world to cover those losses!
Credit default swaps are not the only type of derivative with the potential to destroy the world financial system.
Here's what derivatives had to do with the JP Morgan takeover of Bear Stearns:
http://georgewashington2.blogspot.com/2008/06/derivatives-market-is-unwinding.html
Here's what derivatives had to do with Fannie and Freddie:
http://www.webofdebt.com/articles/its_the_derivatives.php
Banks want the derivatives market to remain opaque:
http://www.globalresearch.ca/index.php?context=va&aid=9202
Banks hidden junk:
http://bloomberg.com/apps/news?pid=newsarchive&sid=akv_p6LBNIdw
Credit default swaps are one of the primary reasons banks and investors were able to use so much leverage and hide risk at the same time. According to Charles Morris in "The Two Trillion Dollar Meltdown":
"And just in 1987, the availability of credit insurance let investors climb higher and higher up the risk curve. Lulled by the presence of credit insurance, investors who might have been wary of the lowest rated CLO's and CDO's snapped them up for their extra risk yields. And why not? The mathemeticians had banished risk.
When money is free, and lending is costless and riskless, the rational lender will keep lending until there is no one left to lend to. Alan Greenspan foresaw a glorious new era of finance. Adding to his string of memorable bubble endorsements, he announced "a new paradigm of active credit management"
Here is the Bank for International Settlements 2007 report on derivatives. 2007 was the peak of the derivatives market. This covers the entire derivatives market and provides statistics on how many of these derivatives are out there.
http://www.bis.org/publ/otc_hy0711.pdf?noframes=1
$700 Billion is Nothing
Our entire economy is a house of cards and has been for some time. The leverage and hidden risk employed by Wall Street gave the illusion of prosperity for a short amount of time. Now that these markets have started to unwind, the powers that be are left with no other choice but to try to kick these problems under the rug and hope that nobody notices. The way this is accomplished is through "Mark to Model" accounting.
The only way to prevent the inevitable was to repeal the mark-to-market rule described above and let the banks keep these assets on their books at whatever valuations they came up with in the original overly-optimistic models. This is called mark-to-model accounting.
http://www.bloomberg.com/apps/news?pid=20601087&sid=agfrKseJ94jc
The use of this accounting rule allows banks to pretend to be solvent. They are no longer required to take any more write-downs. In fact, they were able to write-up the assets that they had written down before the rule change. This made it look as though the banks had recovered even though their financial condition had not changed. The problem with this fraudulent accounting is that it prevents a return to equilibrium. They are just kicking the can down the road. Remember that this whole mess started because asset prices were too high for the average consumer to be able to afford their debt payments. Home prices were too high, gas prices were to high, medical costs were too high. This stress is what helped cause the original defaults that set off the sub-prime crisis in 2007. Peter Schiff explains this whole process very clearly in the clips below.
The Philosopher's Stone (Peter Schiff and Ron Paul)
I think it's time that we start listening to the people who have a track record of being correct. Peter Schiff was warning the public about the impending real estate collapse long before it happened.
Please check out Peter Schiff's website at Europac.net. Peter and his team comb the internet every day looking for stories that they feel have been largely overlooked by the mainstream media.
Below I have posted several clips of Peter Schiff addressing a group of mortgage bankers prior to the sub-prime meltdown. At the time it was extremely unpopular to say anything pessimistic about real estate and it took a lot of courage for Mr. Schiff to appear at this meeting and speak so candidly about what he felt was an inevitable collapse.
He describes very clearly and precisely the steps that the US had taken to weaken its economy and goes on to prophetically describe the consequences of these actions.
Peter Schiff Mortgage Bankers Meeting 11/13/06
In the clip above, Peter hits the nail on the head at abour 4 minutes in when he says that we should have had a much deeper recession in 2002. Instead of letting that recession run it's course we tried to fight it using inflation. This observation is entirely consistent with the chart provided by Jon Williams from shadowstats:
GDP started climbing back up when the inflation created by the federal reserve kicked in. We returned to positive growth for only one quarter in 2003 and even then it was barely above zero. That signal that was misinterpreted by the markets. Investors thought the economy was in a boom when in fact it wasn't growing at all when adjusted for inflation.
At about 2:30 in the above clip Peter talks about how government statistics are manipulated. He goes into great detail about these statistics in his book "Crash Proof". What he says is also backed up by Jon Williams of Shadowstats, Kevein Phillips in "Bad Money", Charles Morris in "The Two Trillion Dollar Meltdown", by Ellen Brown in "Web of Debt" , and virtually every economist who is not sponsored by the fed or a government agency. Why aren't private economists screaming about this fraud every second of every day? Here's why:
http://www.nakedcapitalism.com/2009/09/why-economists-rarely-saw-bad-things-about-the-fed.htmlgs-about-the-fed.html
I know that the above article is talking about the fed in general, but the concept is the same. The Federal Reserve backs the statistics published by the US government. To deny these statistics is to deny any analysis that the Federal Reserve publishes. That is why the above article is very relevant to the statistics issue.
At about 3 minutes into the clip below, Peter's opponent starts attacking the messenger instead of the message. That usually happens when the debater has absolutely nothing left to stand on forcing them to resort to lowbrow tactics (the audience laughs at the guy when he purposely gets the name of Peter Schiff's firm wrong).
Why the Financial Meltdown Should Have Surprised No One
Here is another lecture by Peter Schiff to a group of Austrian Economists. This took place after the meltdown.
12-6-08 Bailout Cost = $8.5T
The Real Scoop on Unemployment
Karl Denninger Commentary on the Banks (9/3/09)
As Denninger (Market-Ticker) very clearly points out, all of our major banks are insolvent as of right now. Since mark to market accounting has been repealed, we never get to see a realistic picture of what a bank's assets are worth until they are seized by the FDIC and the assets are sold in the open market. When this happens we have found that the assets on the seized bank's books were overvalued by up to 40% and no less than 10%. If this is the typical overvaluation of banks' assets, then the entire financial industry is technically insolvent and has been for quite some time.
Colonial Bank's assets were overvaulued by 37% when they were seized:
http://market-ticker.org/archives/1391-Diversions-To-The-Special-Continue.html
As we have seen, most bank assets are covered by credit default swaps. There are enough of these swaps out there to completely wipe out the entire money supply of the planet. The system as a whole is technically insolvent.
I would also like to point out that FASB (Federal Accounting Standards Board) was being pressured to change the mark-to-market accounting rules since October of 2008 (http://www.webeatthestreet.com/index.php?id=572) and repealed mark-to-market on April 2, 2009. Here's how the market has reacted since the new rules were officially adopted:
This is the chart for the Dow Jones Industrial Average for the period 4/2/09 - 10/31/09
The stock market has more than applauded this move to kick all our problems under the rug. Savvy investors know that this move only postponed the inevitable. These investors are certainly going to try to scientifically time their exit.
Black Swan - Chaos Theory (this is a little more esoteric, but hints at the root causes of financial turmoil)
Trends Forecaster Gerald Celente on What to Expect in the Near Future
Jon Williams of Shadowstats.com on Money Supply
The reason why this huge increase in M3 money supply hasn't kept the high rates of inflation going in the year 2009, is because of something called the velocity of money. The Fed did create unprecedented amounts of currency in this financial crisis, but it hasn't showed up in asset prices because that money has not hit the spending stream.
In order for inflation to occur, money must be loaned out to consumers and businesses who will use these funds to buy "things". Remember, the money that the federal reserve creates from thin air is a small fraction of the total money supply once the newly created federal reserve money makes its way through the banking system (see the Money As Debt blog). The faster the money is lent out, the greater the inflation. In normal economic times, the money that the fed prints will multiply at least 10 times over once it makes it's way through the banking system. For example...if the fed created $1B dollars, the end result would be an increase in the M3 money supply of $10B dollars. In the current economic crisis the fed has printed up trillions of dollars that have not even started to make their way through the banking system. Imagine what would happen if the banks opened up their lending standards to pre-2007 levels. The result would be catastrophic inflation because M3 would increase 10 fold or more depending on how fast the trillions printed up by the fed make their way through the banking system. Money has a tendency not to stand still and the trillions I am speaking about have already been created by the fed. The question is...how long will it take for these trillions to make their way through the banking system? If the fed were to try to soak up some of this liquidity before the inevitable inflation picks up speed, the affect on the economy would be catastrophic. Without the ability to borrow money, there is no illusion of economic health, and the house of cards comes tumbling down.
Here's what's happening now...The Dollar Carry Trade:
Recent articles:
Recent Bloomberg article about toxic loans on banks’ books:Here’s what’s happening with mortgages as of 8-20-09 (13.16% of all mortgages are 30+ days behind. Cure rates have dropped from 40 % down to 6%):gger and better fashion than anything Enron could have ever dreamed of):The next wave of foreclosures (2nd wave worse than the first and it’s not subprime that’s the problem this time):Commercial Real Estate (tick tock...tick tock…tick tock)
Here’s what’s coming (SIV’s are similar to the shell companies that Enron had set up in their epic scam. Banks used the same concept, but in a bi
- http://www.calculatedriskblog.com/2007/10/imf-mortgage-reset-chart.html
- http://www.youtube.com/watch?v=shYJ_KkbzWg&feature=relatedre=related
- http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7pUfRPFjS7Q
- http://market-ticker.org/archives/1250-Commercial-RE-Tick...-tick...-BOOM%21.html
(Even the Atlanta Federal Reserve Chief agrees that unemployment is much higher than reported)Derivatives Breakdown (Here’s what the banks are holding on their balance sheets. This doesn’t include what they may be holding in SIV’s. SIV’s were addressed in a Bloomberg article above):Wanna know why booms and busts happen at all? (There are multiple parts to each series. If you have a short attention span then don’t bother):
We’re All Madoff (Nuff said. It’s the American way …or… er… uh… maybe not anymore)
- Click here to go back to the Money as Debt, The Federal Reserve, Debt Slavery page.
Here’s the proof that banks are sitting on delinquent properties rather than foreclosing and taking the write-down on their books:Bailout Reader (just for shits and giggles):
