Time for a book review.

I’ve just finished Michael Lewis’s “The Big Short”. It’s an amazing book, not just because it informs us of the road to the subprime mess but he creates a story around the protagonists. He also manages to expose the whole wretched mess, the fictionalisation of risk and yield laid bare. He introduces us to the main players in the debacle through the eyes of a few weird and wonderful players who worked out that something was terribly wrong and bet against it. These colourful characters expose the whole damn scheme as nothing more than a paper pyramid.

As Lewis sums up the Collateralized Debt Obligation (CDO) on page 73:

“The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America. For Wall Street it was a machine that turned lead into gold”.

Simply put a CDO was a collection (a tower) of subprime loans that had miraculously transformed from junk status to triple A (AAA) credit and therefore it was investible by major funds (referred to in the book as dopey Germans).

So what was the short? Well on one hand you had investors who sold insurance on these debts defaulting. They believed (incorrectly) that it could never happen and therefore they were picking up free money. The shorters realised the were getting amazing odds on the loans defaulting and piled in.

At the bottom of this was an average person with no money and a big mortgage, usually 100% or more. Any fall in the price of their property would immediately put them in a default position. Yes it was a giant pyramid scheme. The real laugh is that even the guys going short didn’t really understand what it was they were shorting so opaque was the structure and process.

I recommend the book very highly. It’s a gripping read and manageable for the layperson.

You’re left wondering how the bankers got away with it. The answer given by the bankers (well laid out in Sorkin’s book) was that they were too big to fail.

This sets us up nicely for the next round.

P.S.

Today the SEC is launching a case against ICP Asset management for their role in handling CDO investments. Along with the case against Goldman Sachs we can expect more companies to be investigated for their role in this financial fraud. It will also be interesting to see when the rating agencies themselves will come under review. They were the ones who gave the AAA blessing to these products they really knew very little about. Makes you wonder about the whole darn shooting match!

Pretty bubbles in the air.

They fly so high,

Nearly reach the sky,

Then like my dreams,

They fade and die.

Fortune’s always hiding,

I’ve looked everywhere,

I’m forever blowing bubbles,

Pretty bubbles in the air.

Never did I believe the mighty Hammers would have understood the machinations of central banking so well. Maybe they knew?

Reading the recent Fed statement, one may feel that the lessons of the recent crisis have not been fully understood or learnt. That’s the problem with the ability to print new money to replace old. It gives a feeling of relief and so help the markets to recover, in fact recover strongly. But there is nothing here that suggests the policymakers know what they are doing.

Crisis dealt with? For now.

As banks continue to go down and credit default swaps unwind it has become clear that we have experienced a crash. Not a one day cataclysm a la 1987 but a more sustained and painful ratcheting down of markets. It’s like being stuck in a falling elevator which shudders to a halt every 10 floors before lurching further down.

Each stop feels like the last but it never is.

After a horrendous week G7 has responded with a new pledge to do whatever it takes.

The question is will they? Do they know what it’s going to take?

They already said this back in April.

It seems to me that the numbers are no long relevant.The game has been up for some time now.

Everywhere you look monetary authorities are looking to buy something whether its banks or stocks.

Forget it…..some banks arent worth it. Deposits in major banks should be guaranteed. That is people’s money not an investment (well it is sort of but not for most).

Stocks should go down to wherever they go down to. The US via the Plunge Protection Team has supported the equity markets for too long.

They should let it act like the market it is supposed to be. Once leveraged trading is stripped out out the market we can go back to buying stocks in a normal investment manner.

As i keep stressing the financial system has been nationalised in all but name. Psycholigically that is hard to take for many because nationalisation is a dirty word to many in the markets, just as priviatisation is to others.

Money is a national tool. Regardless of the shennanigans around the BIS and the Fed and their accountability to government and citizens, we can assume that governments will reassert their sovereign right to coin.

What is interesting in the G7 communique is Point 3:

“3. Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses.”

I like the inclusion of “public” sources.

I think we can expect more and more public money flowing into banks coffers.

Part nationalisation is already here. Depending on how the markets fare from here will determine how far this goes.The margin calls are coming thick and fast and the only place to get cash is from equities. Given the lack of concrete proposals (let’s face it all they are saying is that they’ll bring loads of ambulances) markets will continue to tremble.

The timing has never been better for a sovereign reassertion of the right to create money.

On the US the AMI continues to work on its American Monetary Act and in the UK the Forum for Stable Currencies promotes its series of EDMs on Public Money. More and more we need constructive proposals that can be presented to Government for debate.

There is no time to waste.

There seems to be some suspicion around the Fed’s balance sheet at the moment and questions are beginning to be asked about its capital adequacy.

It’s dolling out cash like sweets at a birthday party. Where is it all coming from?

Last week bank borrowing from the Fed reached an average of $188bln a day!!

All the primary dealers (all 3 of them GS, MS and ML) were in at their teat, the Primary Dealer Credit Facility, for over $100bln.

This is the stuff of legend.

Parker Brothers will be rushing out new Monopoly sets soon with an extra 6 zeros added.

To say the banking system is on life support would be an understatement. Its actually getting CPR……one billion, 2 billion, 3 billion…………

Even the Fed must run out of cash at some point.

Sure the Treasury can sell more paper….but whoa……who is going to keep funding the US Treasury in order to buy toxic paper from the banks?

Who will bail out the Fed?

There is no alternative.

We have no choice but to…………fill in the blank.

There is always a choice. It’s amazing that the USA, Land of the Free, seems to find itself in situations where there is no choice. We must invade, bomb, bankrupt etc. Engineer a huge crisis and then say we have no choice but to send in troops or take all your money.

Watching the negotiations over the “Mother of All Bailouts” is like watching children squabble over a bag of sweets.

But it’s dawning on many that the taxpayer should not be handing over any cash. Sure the government can stand by with liquidity infusions but any investors in banks can write off their cash immediately and that includes bond holders.

If anything this shows that there are always risks in investing even in AAA US Securities. This is a great opportunity for a huge clearout and cleansing of the financial system: making banks carry higher capital ratios would be a good start as it will automatically deleverage the system; making sure the tax system encourages productive applications of capital, away from speculative strcutures.

It doesn’t necessarily mean more regulation. Ultimately investors will have to learn more about the companies and products they invest in: what is a securitised loan, what is subordinated debt, what is a perpetual bond etc.

The rating companies are all part of the game but again new approaches will will be found to get around the conflicts of interest currently present.

Section 8 of the proposed legislation says it all:

“Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.”

Writing out a big cheque with no strings attached is a recipe for more of the same.

Let’s hope the senators are not fooled by Tina. There’s always another way.

As if there could be any doubt about who is running US financial policy it has been announced that Goldman Sachs and Morgan Stanley will be allowed to become “bank holding companies” which will allow them access to the Fed’s discount window thus giving them an easier source of funding.

Shame Lehmans didn’t get this little gift. Then again they didn’t have anyone in the Cabinet to look after them.

It’s no surprise that a recent poll showed American’s most concerned about rebuilding their reputation overseas as their most pressing issue (83%). The country has well and truly gone down the tubes and under a Republican watch. Some mentioned National Socialism was alive and well in the USA.

Stablising financial markets is one thing but underwriting the losses of the banking system is another. This just confirms everything Thomas Jefferson ever said about the bankers and also confirms that the US is no longer the world’s leading financial center.