The Money Party (6): "A Cascade of Ruin"

Monday, 22 September 2008, 11:27 pm
Column: Michael Collins

(Wash. DC) Well, they finally did it. The Money Party exposed the nauseating underbelly of first world finance. It's a cross between a Ponzi scheme and a complex math puzzle, all geared to let those in charge rake off as much money as they can, whenever they can, while they leave us out in the cold. Unfortunately, this time their greed and lack of control has the world poised for a systemic economic meltdown.

The collapse and subsequent government rescue of home mortgage giants Freddie Mac and Fannie Mae, stock brokerage Merrill Lynch, investment bank Bear Stearns, and, an insurance company, AIG, are designed to show we're moving away from the brink of disaster to a safer place. "The system is working" to manage what Alan Greenspan is calling a once in a century event.

One thing the system might do while it's working so hard is explain why we're bailing out a stock brokerage and an insurance company? Isn't this about banks? Don't hold your breath. The corporate elite and political misanthropes who caused this are getting ready to put the final nail in the coffin of the United States economy and the livelihood of the vast majority of citizens.

If this happens, they will have achieved their goal: overshadowing nearly all of the domestic resistance to their schemes of perpetual empire and plunder with a financial meltdown that places survival and subsistence as the highest value.

The stock market rallied last Thursday indicating that some felt better. But who were those buying stocks? The same people who bought into the ridiculous schemes perpetrated by the fallen financial giants: Wall Street and the institutional investors who have the biggest stake in the market "recovery." The soon to fail financial institutions are reassuring each other that those in the tank were somehow different, deviant maybe, rather than the first in a long line of failures to come.

How did it start?

The dot.com stock frenzy was clearly over by 2001. Since Wall Street needs constant growth as a fix for its financial Jones, something had to replace tech stocks. That wasn't easy since good companies with solid products don't offer the type of immediate gratification required for those promising high returns to investors.

In a stroke of warped vision, "subprime securities" were created in 1990. Risky home mortgages called subprime loans were bundled together then sold as a premium investment representing an audacity of hype.

Adjustable rate mortgages (ARMs) became easily available to hard working people struggling to buy a home, people who hadn't qualified for loans in the past. Nobody mentioned that the way the loan was structured they'd be unable to make payments in a year or two.

The funds of other hard working people who hoped to retire someday were used to purchase stocks based on these risky loans. Nobody bothered to tell them that their funds would go down the drain when those subprime loans started defaulting.

Then guru Greenspan made one of the few decipherable public statements of his career. He told home owners about that great opportunity, adjustable rate mortgages. "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage," he said. He went on, "traditional fixed-rate mortgage may be an expensive method of financing a home." Alan Greenspan, Feb. 23, 2004

Greenspan endorsed what was already being done and gave it the patina of a smart financial move. Lower those payments. Get that equity line and catch the Wall Street wave by purchasing stocks. We were "rocking in the free world!" Millions got rich on increased home values.

Real estate prices soared and then they did what they always do. They collapsed, in this case, with a giant thud. All that "wealth" acquired through the housing bubble vanished. Just as the economy slowed, many of those hard working people who just wanted a home were greeted with the full cost of their mortgage. Loan defaults soared and then it happened.

Those premium stocks collapsed. Record bankruptcy and default rates will do that to real estate stocks. Premium subprime real estate stocks became plain old subprime real estate stocks, which is what they were to begin with. Subprime loans vanished. The housing market stalled, then crashed, and there was no new scheme to feed the greed of the geniuses who thought up this scam.

Home value and retirement funds are taking a massive beating. It's survival of the fittest for the vast majority.

But the planners and perpetrators of the scheme are doing just fine. The current rulers decided it's time to expand socialism for the rich. In full public view, they're bailing out the people who created and pushed this crazy scheme. How many in the management chain are getting fired? Not many, it seems.

Is this just another example, outrageous as it is, of the super wealthy taking care of each other or is there something even worse lurking in the wings?

What are they hiding?

Each financial entity bailed out so far had major holdings in the very risky financial product called derivatives. Merrill Lynch even bragged about getting the "Risk Magazine" award as "Derivatives House of the Year 2007.

Warren Buffet sees derivatives as a major threat: "The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear." He went on to describe derivatives as "weapons of mass financial destruction." These financial products were valued at $516 trillion dollars in 2007. The value of world economy was $65 trillion that same year.

Overly complex and insider oriented, derivatives are designed to "reduce risk." They are, in fact, the looming mega risk that apparently can't be discussed. If the derivatives market collapses, interlinked major financial institutions around the world are finished. The financial system will have failed.

Analyst and author Michael J. Panzer describes derivatives as clearly as possible:

"-- it is not hard to grasp the basic economics of a garden-variety derivative such as a futures contract. If the market price of wheat goes up between the time a deal is struck and the expiration of the agreement, the buyer wins and the seller loses. That is what is known as a zero-sum game. Nonetheless, whatever a farmer, to use the earlier example, might give up as a result of hedging his output is offset by the reduced uncertainty.

"But it is an altogether different story when it comes to analyzing options, or a portfolio of derivatives, especially those with lots of complicated bells and whistles. In most cases, valuation and risk assessment depend on mathematical formulas and computerized models, with many inputs derived from estimates and past data. That is all well and good if the tools are perfect and the history is complete."

Panzer goes on to point out that the history, data, and assumptions used to analyze value and risk are often sorely wanting. Hence, this pervasive financial product is a risk, in and of itself, due to questionable assumptions.

These products are sold by very aggressive financial services groups based on serene assumptions. For example, the products often don't factor in the impact a recession derivatives. David Amerman made the point in simple terms. If sellers will target home buyers who can't pay loans, we can count on bigger sellers going full tilt to get major commissions on this widely held financial product.

So the financial geniuses have created a market that has no relationship to reality, other than the reality conferred arbitrarily by banks and brokerage houses. Michael J. Panzer explains how something this detached from oversight takes hold:

"In the modern global financial system, where many participants are either unregulated or are monitored by a patchwork of country or sector-specific regulatory overseers, chances are that a derivatives-related catastrophe will see a similar lack of coordination that will produce a far more devastating outcome than if it was a purely domestic affair."

What is the real value of the derivative market? It would be helpful to know that given the reliance of our banking and financial services industry on these financial phantoms. More importantly, for our current circumstance, what happens when enough people realize that there cannot be a value commensurate to the amount claimed?

This teetering derivative market can't be bailed out. There simply isn't enough money. But our rulers think that the banks, insurance companies and stock brokerages heavily indebted and riddled with derivatives can be saved. As Ellen Brown pointed out last Thursday, save them and you stop the full exposure of the derivatives market. You avoid the risk of people finding out that their money and investments are being held by institutions willing to invest in financial products that are, at the least, highly speculative and, at the worst, pure vaporware.

The current risk was triggered the forgotten assumptions in the home mortgage derivatives market like recessions. Here's what's next. "The $62 trillion dollar credit derivatives market is 50 times the size of the subprime mortgage derivatives market, and is indeed larger than the entire global economy." David Amerman

Is it any wonder that we're faced with an economic crisis, one that encompasses the entire economic system?

The Paulson Secretariat

The White House has selected Secretary of the Treasury Henry Paulson to lead an economic "Charge of the Lite Brigade" to prevent a total economic meltdown. A version of the administration's rescue package is available online. What's missing? There is no requirement for "the bosses" to restrain their behavior, take a pay cut, or suffer any consequences. It might tarnish their self esteem.

But the real treat is the unfettered authority of the U.S. Secretary of the Treasury, Henry Paulson, to obligate citizen debt in order to rescue incompetent banks, brokerages, and other failed institutions. Citizens will pay the bill but have no influence on Paulsen's decisions. Here are two revealing provisions from Bush-Cheney White House proposed legislation:

"Sec. 2 (a) Authority to Purchase.--The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

"Sec. 8 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." (Emphasis mine) White House bill,

So here's the plan in summary. You bail out those companies that caused the current crisis based on what one guy wants to do. You don't allow any review of the process of spending $700 billion. And, you let the management and key staff of these companies stay in place to do it all over again.

Tinkering with the bill to provide oversight, input, monitoring misses the point. The bailout is the wrong approach. To begin with, oversight has failed again and again in the financial markets. More importantly, it ignores the next crisis, credit default swaps, and rewards the meltdown perpetrators. Nobody tells the truth about this being the tip of the iceberg. Nobody faces any negative consequences. Most everybody stays in place.

How about somebody in authority coming clean?

When is someone in authority going to tell the truth, lay out the facts, and take responsibility for this mess? Never, unless we make that happen. The mechanisms readied for approval will be sold much like the Patriot Act; steamrolled due to times of crisis. Those who speak out against another element of tyranny put in place will be ridiculed. Protestors will face the newly outfitted local law enforcement anti terrorism units who are more than willing to arrest anyone who disagrees with the administration, even in heavily Democratic cities like Denver, Minneapolis, and St. Paul.

The perpetrators can position all day long, taking advantage of the citizens through a quiescent White House, Congress, and judiciary.

But the truth will emerge - the country is broke and not because we don't work hard enough, make good products, and provide quality services. We're broke because the greediest people in the world couldn't contain their greed and there was nobody watching them who wasn't benefiting. Now the watchers are desperately trying to make it all go away.

There needs to be an accounting and a correction - and not by the usual suspects.

Here's one way to start with derivatives crisis in major institutions:

"If all the top 25 financial institutions were put into receivership, and (big if) if they all could be liquidated under an agreed legal framework, many of these risky contracts could be allowed to offset each other, and much of the risk eliminated."
Private correspondence, Numerian, The Agonist, Sept. 21, 2008

For more information see:

It's the Derivatives, Stupid! Why Fannie, Freddie and AIG Had to Be Bailed Out by Ellen Brown, Sept. 18, 2008
Letter to my Senator by Numerian, The Agonist, Sept. 21, 2008
The Coming Disaster in the Derivatives Market by Michael Panzer, Nov. 9, 2005
AIG’s Dangerous Collapse & A Credit Derivatives Risk Primer by Daniel R. Ammerman, CFA, Sept. 17, 2008
LEAP/E2020 Summer 2008 Alert – July-December 2008: The world plunges into the heart of the global systemic crisis. Global Europe Anticipation Bulletin, Summer, 2008

Previously in The Money Party Series

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