Tao Economics

This weekend's Tickers have exposed the same thing on Tickerforum that is rife throughout the country and political class.

In response to pointing out the mathematical facts relating to money, credit, debt and the compound nature of interest (and thus debt), there has been a persistent call for the impossible.

As just one example, a call for The Fed to simply print money at some ridiculously low interest rate, however much it needs to (ignoring that all money is in fact a bond on future tax collections, and therefore is debt and increases the base subject to that exponential growth) to "inflate away" the debts that people can't cover.  (Never mind that prices rising while wages do not, while taxes ultimately must increase as foreigners demand more to buy and hold bonds bankrupts you anyway.)

Folks, there is really no point in attempting to provide the mathematical reality to you, or anyone else, when the incessant response to such an attempt is to simply ignore the mathematical facts and demand that which is impossible.

It is akin to expecting that magical Unicorn to appear, or appealing to Santa Claus for your wish.

It isn't going to happen.

I recognize full well that expecting people to actually think and verify the mathematical facts of a matter is considered "uncouth" these days.  After all, we can all be skinny, beautiful and have an erection any time we like, just so long as we send $19.95 to the address on our TV screen.

There are, unfortunately, two groups of people on this planet.

Group #1 includes people like Buffett, who understand the principle of compounding (anything.)  Whether it be population growth, interest, debt, or earnings, they learned the power of exponents early in their life and it "stuck".  They, as I, when presented with something like "GDP grew 5% last year", instantly extrapolate that outward some period of time and start to mutter under our breath.  When we hear of 3% population growth annually, we become alarmed.  When we hear of oil demand going up 2.3%, we freak out.

Group #2 hears the same number and thinks "oh that's not much."

Group #2 is 99% of the population of the United States and this must change.

The power function is in fact the most important mathematical concept in the universe.  It is the factor, standing alone, that dashes all of the dreams of politicians, engineers and the "pumpers" of various schemes alike.  It is the reason the housing bubble could have never succeeded.  It is the reason the Internet bubble was doomed to pop. It is the reason that Madoff could not maintain his Ponzi scheme. It is why "just a little inflation" always winds up in a deflationary bust. It is the reason that irrespective of what our President, Treasury Secretary or Chairman of The Federal Reserve want, the pain that we MUST take simply gets worse - and at an ever-increasing rate - the longer we delay in taking it.

Bubblevision this morning on CNBC said that "redemptions" forced Madoff to confess because he ran out of money.  Nonsense.  The power function did that - in fact, it guaranteed that he would run out of money.

In fact, CNBC has their anchors around the desk this morning arguing that this was a "great scam"; that absent the downturn in the market he would have gone to his grave without having to give up his secret.

Well, perhaps, but eventually it would have been exposed, and the bottom-line reason is not due to the market crash this last autumn - it is the inevitability of the power function that always brings down Ponzi schemes.

When history is written on how we wound up in this mess and why we the people refused to demand the politicians stop doing the insane, certainly this will be a major component.  It is not simply about greed, it is about a blanket refusal to sit down, take 5 minutes with a piece of paper and calculator, and think a situation through.

We just won't do it, either individually or in our Media, who is allegedly charged with pointing out the truth.

Instead, we listen to people who appear on the Boob Tube or those who have letters after their names, even when what they speak of is utter rubbish - and they know it.

Remember Dick Cheney - "Deficits don't matter"?  Uh huh.  They don't matter forever, right?  What he really said was "exponents don't matter."

Pull the other one, DICK.

To those of you who are reading this and have taken the few minutes it requires to sit down with a calculator and "get it", congratulations.  Your job, should you choose to accept it, is to get 100 people each to also "get it". 

Take your calculator with you.

It requires just minutes for the light bulb to come on.  Take any small growth rate (say, 4%) expressed as a decimal (1.04) and raise it to the 100th power (that is, 100 years of compounding.)

Your "little" 4% growth rate turns into fifty times whatever you started with, not the four times increase you might (if you're not conversant with the power function) expect.  If that's an annual population growth rate for a city, and you start with 1 million people, there are now 50 million people in that city, not four million.

Will they fit?

By the way, it gets a LOT worse if the percentage growth is even "somewhat" higher.  Do that exercise again for 7%.  Make sure you're sitting down and do not have a mouthfull of coke - or coffee - when you push the buttons on that calculator.

Maybe - just maybe - that's enough to start a fire somewhere and get something done about all this, because in fact, the power function is the most important function in the mathematical universe, and it limits all attempts to have "growth forever."  Refusal to acknowledge mathematical facts leads to pain, and lots of it, because mathematics never - never - lies.

I'm not confident, because far too many of you are still looking for the Unicorn that craps Skittles, and are absolutely convinced that he is just around the next corner.

I wish you the best of luck in your quest.

I'm referring to CHARLES EVANS, President of The Chicago Fed, JAMES BULLARD, President of The St. Louis Fed, and Janet Yellen of The San Francisco Fed, along with CHAIRMAN BERNANKE.

The former wants to "mimic" below-zero interest rates, while Bullard wants an "inflation target" and Yellen says "its worth pulling out all the stops" according to speeches today.

All are displaying absolute panic as the reality of what they have done has finally crossed their conscious barrier and is now staring them in the face.

Yellen's commentary is particularly outrageous:

“Although our economy is resilient and has bounced back quickly from downturns in the past, the financial and economic firestorm we face today poses a serious risk of an extended period of stagnation,” which may intensify financial-market conditions, Yellen, 62, said during the annual meetings of the Allied Social Science Associations and the American Economic Association.

“It’s worth pulling out all the stops to ensure those outcomes don’t occur,” she said."

Why outrageous?  Because The Federal Reserve has been both complicit and actively involved in creating the mess we find ourselves in today!

Rather than come out and admit the outright stupidity that they have practiced over the previous ten years, starting most notably with Greenspan's bankrupt economic policies, they instead are desperately searching for some way to beat the laws of mathematics, lest angry crowds figure out the scam, descend on their tony little country clubs and find a new use for a 4-iron!

Every last one of these clowns is fully aware of the fact that interest is a compound function - that is, it is an exponential function.

Let me make this clear: every single person in this country who claims to have a High School Diploma should understand this without prompting. 

They clearly do not, or we would have 200 million Americans literally storming every Federal Reserve Bank office and the home of every one of these "masters of the universe" and Washington DC, forcing the lot to admit to their central role in the mess we now find ourselves in and demanding that they stop it right now and instead force ALL of the bad debt out into the open where it will be either paid down or default.

Why?

Because mathematics is never wrong, whether you liked the subject or not in school, and making claims that violate the laws of mathematics is always and everywhere an act of fraud.

So here's your education folks - the education you were supposed to get in High School Algebra Class, if you were actually awake and paying attention instead of smoking pot around the corner and dreaming of that cute girl (or guy) in the next chair over. 

And to you the so-called Teachers in our schools, all of you need to be fired.  Every last damn one of you.  Not one of your so-called "students" who doesn't get this should have passed.  NOT ONE.  When the history books are written on the destruction of our economy - the first part of which is happening right now - there will be a special notation made for you who failed to teach the basics of mathematics to our citizens - knowledge that, had it been actually taught according to the claims you have made over the years, would have prevented this stupidity from happening. 

We're going to do this first the "hard way".

Assume 10% interest (very low on a credit card eh?) for 5 years.

MOST people in this country don't think that's so bad, because they'd only pay 50% (in total) interest on the money.

WRONG.

Here's the math:

In the first year, $100 @ 10% interest is $110.
In the second year, $110 @ 10% interest is $121 (oh oh, here it comes!)
In the third year, $121 @ 10% interest is $133.10 (heh, what's going on?)
In the fourth year, $133.10 @ 10% is $146.41 (why is my butt sore?)
In the fifth year, $146.41 @ 10% is $161.05!

And it gets worse from there.  A lot worse.

Now I could sit down and do this for every year out to, oh, 20 years.

But I don't have to.  See, I have this thing called a Calculator, and you probably do too.  You can do this calculation for ANY interest rate over ANY number of years with just a couple of keystrokes.

Its the "Exponent" key, sometimes labeled as yx

On the HP12c, to perform this I can key in:  1.1 <ENTER> 5 yx and VOILA!

Now let's do it the "simple way" - 10% interest over 10 years.  You pay "twice" for that item, right?  10% interest, 10 years, 100%.  Right?

WRONG.

You pay 2.5937 times for that item, or nearly sixty percent more than a simple doubling, due to the exponential nature of interest.

Now let's take your 29% interest that the credit card companies want to charge nowadays, and figure out how badly you get screwed by that in ten years.

Ready folks?  You will pay NOT roughly three times the original purchase price but rather TWELVE POINT SEVEN SIX TIMES the price.

That $10 pizza at 29% interest over 10 years will cost you ONE HUNDRED TWENTY SEVEN DOLLARS AND SIXTY CENTS, WITH ALL BUT $10 OF IT BEING INTEREST!

If you go talk to any real scientist (in any discipline) and start describing a system that is exponential but which must operate in a world (closed system) that has finite limits he will instantaneously freak out.

That is because what you have described is a system that is mathematically impossible to maintain.  The exponential growth (even with a very low exponent - that is, a very low interest rate) will always eventually cause the destruction of the system. 

ALWAYS.

We are simply arguing over the when the destruction takes place.  We can either choose to destroy the excess debt before it reaches the critical point or that destruction will happen in a totally uncontrolled fashion and take down our economy and government.

THIS is the fallacy of The Fed's BS and games, and its the fallacy they are counting on you not to understand.

This is why none of their "money printing" can or will work because all money is in fact debt (go see the previous Ticker) and interest is an exponential function.

It is why it did not work in 2000-2003 and will not work this time.  It can't work because the laws of mathematics are facts, are not subject to interpretation, and no amount of political BS, lies and jawboning change them.

Each and every one of you who claims a High School Diploma learned this stuff in school!

Let me make this crystal clear: All exponential functions will, every time, consume the entirety of any fixed-size system (e.g. the planet earth, which is fixed in boundaries and resources) given sufficient time, so long as the rate-of-growth is a number greater than 1.0.  This is a mathematical law and nothing can change it.

There is exactly one way to stop this destruction, and that is to reduce the rate-of-growth to less than 1.0.  The exponential function then runs "in reverse" and shrinks at an ever-increasing rate, and the damage that must occur is thus stopped (and recognized) at that point in time.

When we are discussing debt the only possible way to reduce the rate-of-growth to below 1.0 is for the total debt in the system to be reduced.

There is exactly - and only - one solution: the unservicable debt that is currently being hidden must be forced into the open and defaulted, since it is being hidden and tampered with for the precise reason that it cannot be paid down - the only other way to get rid of it.

Nothing else will work. 

Mathematically, nothing else can work. 

Central bankers, policy makers and politicians claiming that they can "help" the situation by taking on more debt are arguing for driving the exponent higher.  This makes the problem worse, not better.

America: You had better wake the hell up because the longer we wait to stop this, the worse the economic collapse is going to be. 

There is no possible path forward that does not involve the massive loss of jobs and wealth, but the exponential nature of ALL interest and growing debt guarantees that the longer we keep screwing around the worse it will get.  We must stop trying to prevent defaults - indeed, we must force inevitable defaults to take place now because that is the only way to interrupt the exponential function.

We are now choosing between amputating FINGERS and ARMS.

I wrote about this in "Monetary Flat Spin" but it keeps coming up in the forum, and reading back through that posting it appears a bit, uh, "obtuse."

So here's a second attempt - one that hopefully is simple enough that everyone in America, including Congress and Obama, can understand.

We must start with what "money" in the context of "Federal Reserve Notes" (whether electronic in your bank account, bills in your wallet, or "new bank reserves" created by Bernanke) actually are.

You think of a "dollar" as money.  But what, in a modern monetary system, is money?

It is in fact always debt.

The "usual means" by which "money" is created is that the Treasury prints up some T-bills and gives them to The Fed, which in turn gives Treasury dollars.  Treasury then spends those dollars into the economy, increasing the monetary supply.  In theory the economy grows, Treasury collects taxes, and (in theory) can pay off those Treasuries, which would destroy the money (and debt) thus created.

But recently Bernanke has been buying up things like mortgages and simply creating new bank reserves (dollars.)  The important thing here is that he is doing this with existing debt (mortgages) for which someone already paid - this is said to be "printing", or issuing dollars not backed by a debt instrument.  This is alleged to be why what he's doing "can work" to unclog markets and help our economy and gives rise to the "Helicopter" analogy.

Bluntly: He's wrong and if he, and Congress (along with Obama) do not cut this crap out they will destroy our economy.

Why does a dollar have value?  A dollar in fact has value only because people believe in the Federal Government's ability to continue to exist.  Should The US Government cease to exist for any reason, dollars would instantaneously be severely devalued, and might become worthless.

How does the Government continue to exist? The Government continues to exist because it is able to levy taxes on your productive output.  That is, your income and other activity generates a tax liability to the government, which you are then obligated to pay.  This "siphoning off" of production is how the government funds itself.

So therefore, a dollar is in fact an indefinite-maturity bond carrying zero interest written upon the future production of the citizens of The United States.

That is, money is always, irrespective of how it comes into being, debt!

To be plain, a dollar is a debt instrument written against you just as certainly as is your mortgage or car loan.  Yes, it is by a more circuitous route, but in truth it is exactly the same thing when one strips away all the BS and games.

To the extent that these dollars that are created are exactly matched against actual production (defined as growing something, mining something or manufacturing something - that is, an action that can ultimately be traced in it's energy to the sun, the only source of a "freebie" in our solar system) there is no inflationary or deflationary impact, as the debt in the system is exactly matched against the output in the system.  The monetary system is in balance.

This is true for all modern (non-hard-asset backed) monetary systems.

We are in this mess because we created too much debt for the balance of the system.  That is, too many people bought houses with too much leverage (that is, too much debt was being taken on compared to actual production represented by salary), companies were purchased with too much leverage (the "M&A" game) and so on.  Mortgage-backed securities, credit-default swaps, all of these are forms of debt and their issuance was deregulated to the point that people's "animal spirits" drove prices much higher, as leverage was employed at higher and higher levels.

It is obvious that you can't do this forever; ultimately someone asks to be paid with actual production (instead of more shuffling of paper) and oops - there's not enough production to pay with! 

You get BOOM!

That, by the way, is exactly what happened in 2000.

But our wonderful government who either didn't understand the essence of what money is and that it is debt, or was intentionally misled by a few who did, decided to paper over what should have been a really serious recession (9/11 didn't help!) and deceive the public.

Did it work?

To those who argue yes - we went from 260% of GDP (that is, ~$26 trillion dollars) to over 360% of GDP (that is, ~$50 trillion dollars) in outstanding debt, public and private from 2000 to 2007. 

At the same time, the aggregate GDP went from $10 trillion to $14 trillion; if that increase was linear then it was ~2 trillion annually (on average) over seven years, or $14 trillion in total (that's a mathematical simplification; don't shoot me for it!)

But we added $24 trillion in debt.

So in fact Greenspan's policies and those of the rest of our government did not produce growth in GDP.  It simply "pulled forward" demand from future years and left us with a bigger problem - we actually suffered a net contraction, on aggregate, of $10 trillion, or about 3/4 of a trillion dollars annually in real aggregate GDP (represented by production and current-day consumption, not pulled-forward demand financed by new debt.)

This is why if you are in the middle class you have been squeezed relentlessly over the last seven years.  Your wages have actually gone DOWN in terms of purchasing power because of the debt taken on - it has pulled forward demand but that "growth" is in fact illusory as the debt remains but the consumption has taken place and is finished, leaving you only with principal and interest payments on that debt that depress your current purchasing power.

So the 00-03 "stimulus", including the tax cuts, interest rate cuts and even direct checks did not actually stimulate the economy; it simply hid the contraction in a way that tried to make you feel good and allow you to keep your standard of living intact for a short while by borrowing from the future!  That, of course, made the inevitable contraction worse because we now must default all the new debt used to paper over the previous mess along with the all the old!

What our government has proposed and done now is several times worse.  We took seven years to go from $5.7 trillion dollars in public debt to $9.2 trillion - a gain of 61% - but in the last year alone we have gone from $9.2 to $10.7 - a gain of 16%!  Annualized over seven years this would be a two hundred and ninety percent increase, and Treasury isn't counting the seven trillion in forward commitments that aren't reflected in that number, nor are they counting the five trillion more represented by Fannie and Freddie.

Has that 16% increase - a $1.5 trillion addition to the debt - made the economic situation worse or better over the last 12 months?  The stock market - has it gone up or down?  Employment - has it increased or decreased?  Has your credit card and home equity line become more or less accessible to you?  Has your house value risen or fallen?

Please note - the growth in debt necessary in the attempt to prevent the liquidation (that's a fancy word for "Bankruptcy") of the bankers who overextended credit (and the consumers who took it on) is in fact an exponential function.  That means that it compounds upon itself, as we have now seen - we have now spent or committed more new debt in the last twelve months (nearly $7 trillion dollars!) on The Federal Government's part alone than we committed over the entire previous seven years.

You cannot cut taxes to get out of this, you cannot deficit spend to get out of this, nor can you raise taxes to get out of this box.  The only way to get out of the box is to pay down or default the debt, both of which are by definition destructive to GDP and the economy, until the level of debt in the system as a whole is reduced to a sustainable level.

What government has done to date and proposes to do cannot work any more than it did the last time.  We know this for a fact because it was done just seven years ago and failed to produce lasting prosperity.

These actions failed (and will again) not because they were "not big enough" or "ill timed" or any such claptrap - they failed because it is mathematically impossible for them to succeed.

The problem is that there is too much debt in the system; adding more debt to the system simply makes the problem worse at an exponentially-increasing rate.

It is impossible to fix a problem that is best explained as "too much" of something by adding more of that same thing. 

This is true whether the "too much" is a drunk who wants a bottle of whiskey, a crackhead who wants another hit, or a heroin addict who begs for another shot.

You can't solve any of their problems with more of what ails them any more than you can solve a debt problem with yet more debt.

Our government's actions to date and Obama's plans will fail; any "benefit" that appears will be fleeting and simply compound the necessary pain that we must take in order to clear the economy.

Irrespective of whether the bankers, homeowners and government like it or not, the insolvent will be forced into the open and bankrupted.  We are only arguing over whether the government does the right thing and forces it to happen now or whether it occurs as part and parcel of a full-on economic (and possibly government, if they don't quit taking on debt themselves!) collapse.

Those are the only two choices. 

There is no other solution that is mathematically possible, no matter what you are told - or by whom.

I strongly suggest that you prepare for our government to do the wrong thing, and to lie to you for as long as it is able.

Not mine but sent to me by email, and I had to reproduce it....  someone on the forum pointed out the source.  Gotta love 'ya Charles; here's the link.... :)

FROM THE OFFICE OF SATAN
"Prince of Lies and proud of it"

Dear Hank:

You have outdone yourself once again, my loyal servant, with these fraudulent, deliciously deceptive proposals to reform the utterly corrupt financial system you exploited so profitably as head of Goldman Sachs.

My plans for the destruction of the United States of America have been going along rather swimmingly until we rushed things a bit with Bear Stearns--ah, the wondrous power of pure, unmitigated greed! It remains my favorite tool--and calls for reform were suddenly everywhere.

The rules which would have undone us were simple indeed, as you know all too well:

1. complete transparency of risk and leverage in all financial documents and financial instruments
2. the marking to market of all financial instruments and assets at the close of the trading day, as is currently done with commodities futures and stock options
3. the banning of "off balance sheet" accounting
4. the banning of offshore accounts and holding companies
5. the uniform enforcement of these regulations across all financial classes, assets, firms, brokers and banks

As you know, Hank, transparency, mark-to-market and strictly enforced regulations of all banks, broker-dealers and financial institutions would deal a death blow to my plans to destroy the U.S. via destruction of its financial system. Having sold your soul to me for the glory and riches you received at Goldman Sachs, you had to comply with my orders to destroy any such useful regulations with cunning "fixes" of your own.

Though I counted on your native feral survival instincts, I did not expect a plan of such evil genius. Imagine how foolish and naive humans must be to accept your "fix"! My mind boggles at the ease with which you have conned the gullible gallery of idiots in Congress and the mainstream media:

1. You diminish the powers of the Federal agencies and favor the "shadow government" Federal Reserve, which is not even a government agency but a private institution.
2. Instead of proposing transparency, you are adding another layer of secrecy in what the Fed can investigate and do to "fix" future problems.
3. Enable more "self-regulation" (hahahaha, I can't stop laughing at this one! You really are a comedian!)

I am still amused that the American populace hasn't noticed that you, Master of the Dark Arts at Goldman Sachs, have been duly appointed as the wolf assigned to guard the sheep. Now you have suggested opening the rusty wire fencing and lighting the opening so your brethren can more easily slip in and slaughter as many sheep as they wish--and the American sheep sit there mesmerized by my other crowning achievement, the TV, blithely accepted that the most voracious, cleverest wolf is now their "guardian." Never in my wildest imaginations did I hope for such gross stupidity, ignorance and naiveté.

Keep up the fine work--

Your Lord and Master,

Lucifer

"Insanity: Doing the same thing over and over but expecting a different result" - Albert Einstein

One of the brightest men ever to walk the earth.

President Obama (in a bit more than two weeks) doesn't even make it into the bush leagues compared to Mr. Einstein.

Here's his latest:

“These are America’s problems, and we must come together as Americans to meet them with the urgency this moment demands,” he said today in his weekly radio address. “If we don’t act swiftly and boldly, we could see a much deeper economic downturn that could lead to double-digit unemployment.”

Well, you got it half right Mr. Obama.

The half being that these are America's problems, and we must meet them with urgency.

The half you got wrong is that your prescription will make it better.

Specifically:

"The incoming 44th president, back on the U.S. mainland after a 12-day vacation in Hawaii, is working on a package of tax cuts and spending on infrastructure, such as roads, bridges and transit systems, to stimulate growth and create 3 million jobs. Eighty percent of these will be in the private sector, he said. "

Uh huh.  And where will you get the money?

Oh, you'll simply load on more debt, right?

Isn't that how we got here in the first place - spurring on more debt after the 00-03 Tech Market implosion?

Indeed.

You also have recorded history on this, which says it doesn't work.  Japan, for instance, as the WSJ points out:

"Not to spoil the party, but this is not a new idea. Keynesian "pump-priming" in a recession has often been tried, and as an economic stimulus it is overrated. The money that the government spends has to come from somewhere, which means from the private economy in higher taxes or borrowing. The public works are usually less productive than the foregone private investment."

No kidding.  Never mind that the debt remains left behind, and it continues to drag on the economy in perpetuity.

The problem is who you're listening to.  People like Buffett, who should have (and could have) avoided a huge drawdown in Berkshire's value - but didn't.  People like Geithner, who along with Bernanke know how to perform compound interest calculations, but simply didn't care during the 03-07 time frame. 

Along with Paulson they supported the removal of leverage limits, repeal of Glass-Steagall and other regulatory "reforms" that effectively let the banking system place huge bets with non-existent capital - exactly identical to walking into a Casino in Vegas and writing worthless markers.

The only difference is that when you do that sort of thing in Vegas you either go to jail for fraud or Guido breaks your kneecaps. 

In Washington DC you get made Treasury Secretary and are able to cash out $500 million smackers for yourself, tax free, then bill the Taxpayer for your obvious and blatant line of BS.

The people of this nation voted for change Mr. Obama, not "more of the same." 

Yet "more of the same" is exactly what you're proposing when it comes to economic policy, even though if you are really as intelligent as you (and others) have claimed you know full well it won't work.

10% unemployment? 

What you're doing here will guarantee 15% unemployment.  Oh, perhaps not immediately, but I'm willing to wager you won't get to the end of your first and only term before this all comes crashing down on your head, and it may happen within the year.

You cannot solve the problems this economy has until the bad debt is forced into the open and is either paid down or defaulted, the liars are locked up for their crimes, the off-balance-sheet games are permanently halted and the laws that prevented this crap from happening are reinstated and, more importantly, enforced.

I've seen exactly none of that proposed by you sir, which tells me that instead of preparing for a better future ahead of myself and my family I should instead prepare for economic and political Armageddon, for the path you are on and the one your advisers are recommending to you is certain to lead to disaster.

Oh, and if you think The American People are going to fall for it, well, how do you say "good luck" in Japanese?  Being lied to and bamboozled now for over 20 years, the people are waking up fast to the fact that folks like Madoff are not the exception - they're the rule - and that these scams, frauds and charlatans could only exist with not only a willful blind eye in Washington DC but with explicit involvement and complicity in the fraud.

Ultimately the Wizard is either forced to sheepishly admit the truth and do the right thing or he risks the people starting to pen documents that begin with the sentence "When in the course of human events......"

I'm not even sure I believe this came out of Paulson's mouth:

Global economic imbalances helped to foster the credit crisis by pushing down global interest rates and driving investors toward riskier assets, outgoing US Treasury Secretary Hank Paulson told the Financial Times.

Really?

Global economic imbalances?

But Mr. Paulson, didn't those "global economic imbalances" take place over a couple of dozen years? I seem to recall that China has been making cheap crap for The United States for a very long time, and it has not just been in the last couple of years that it turned into a problem, right?

Never mind your (and Bernanke's) "solution".  Once again:

Paulson: "Global economic imbalances helped to foster the credit crisis by pushing down global interest rates"

So your (and Ben's) solution is to push down global interest rates when that caused the problem in the first place?  Isn't this kind of like giving a Heroin Addict a bag of smack when he's got the shakes and calling the problem "fixed"?

Hmmmm.

“Excesses . . . built up for a long time, [with] investors looking for yield, mis-pricing risk,” he said. “It could take different forms. For some of the European banks it was eastern Europe. Spain and the UK were much more like the US with housing being the biggest bubble. With Japan it may be banks continuing to invest in equities.”

This argument – already advanced by a number of economists and largely endorsed by Federal Reserve chairman Ben Bernanke – suggests that the roots of the crisis do not simply lie in failures within the financial system."

Investors mis-priced risk?

Or did you mis-price risk Henry?  Perhaps on purpose?

Why would your company, for example, short something it was selling to investors unless it thought it was overpriced?

Now there's nothing wrong with shorting a stock or bond, of course.  Its the expression of an opinion that the price is too high.  You believe it will decline in value, so you short it.

Except for one problem - in this case you were one peddling the stuff you were shorting!

So on the one hand we have you telling your customers that this is "Grade AAA mortgage paper", and on the other hand your firm was shorting that very same paper, implying rather strongly that you thought your customers were paying too much for it.

Oh, you didn't tell them that either, did you?  That's what I thought.

Now let's talk about what else happened Mr. Paulson.

In 2000 you do recall that you went to the SEC and Congress to request that the leverage limits that bound Goldman Sachs (your company) and the other investment banks be removed, right?

You also remember that in 2004, following that failed attempt, you tried again, and this time your request was granted, right?

You do recall that every one of the failed firms - Lehman, Bear, Fannie, Freddie and AIG - all had leverage more than double that of the previous limits when they blew up, right?

Again, you said:

Spain and the UK were much more like the US with housing being the biggest bubble.

Yes Mr. Paulson, and what do you need to create a speculative investment bubble?

Why you need lots of credit - that is, debt, right?

And how do you get lots of credit Mr. Paulson?

Why you increase your leverage.  And when 14:1 isn't enough, you go to Congress and the SEC and ask them to remove the "shackles" so that your "finely tuned risk models" can take on more leverage - that is more debt, which is a necessary condition to grow such a bubble.

So now we get to the bottom of this entire charade by your own admission, which is that you personally were largely responsible for the mess we find ourselves in.

But that's not all!  We also have the following statements from you that constitute lots of claims that there is no mess:

May 2007: "We think it is near the bottom.  It will take a while to work its way through (the system).  Fortunately for us, we have a very diverse, healthy economy.  ..... housing will be contained......

August 2007, in Beijing: "There's a wake-up call and there's an adjustment to the repricing of risk, but I see the underlying economy as being very healthy."

October, 2007, on HOPE NOW:  "This is a 100 percent market-based solution.  I believe in markets."  You added: "I've seen turbulence in the market a number of times and I can't think of any situation where the backdrop of the global economy was a healthy as it is today."

March 2008: "The worst is likely to be behind us."  (In reference to Bear Stearns going under.)

July 2008: Your famous "Bazooka" quote, and not needing to use it, and less than a month later, in late August, you said "We have no plans to insert money into either of those two institutions."

September 2008: (Two weeks later!) $200 billion is committed by Treasury to Fannie and Freddie.

September 15th 2008: You congratulated yourself (and Treasury) for not rescuing Lehman - but the very next day you committed the taxpayer to an eighty five billion dollars rescue for AIG, and less than 72 hours after that you threatened martial law and a total collapse of the entire financial system if you were not given $700 billion more to spend in any way your heart desired.

Now with just three weeks before you will leave office in disgrace you say that it never was contained and that this was born out of "global imbalances" that were years in coming.

Years during which you personally were head of a firm that shorted the very securities that blew up and caused the mess, while marketing them to investors, and in addition you personally lobbied Congress and the SEC to permit your firm and the rest of Wall Street to increase their leverage - a move that was directly responsible for the failure of each and every one of the firms that has blown up and created the mess.

I want to know what you're smoking and where you got it, because its damn good stuff.

And as for "containment", my recommendation is a nice Federal Prison - 50 years worth should be about right - we'll keep the bones on display as a warning to future similar malodorous slime if you aren't breathing for the duration.

Let's score the 2008 edition predictions first:

• US will enter a recession: Confirmed by NBER.  Check.
• Unemployment will rise north of 5%.  Check (bigtime)
• Housing will not turn in 2008.  Major check.
• The story in 2008 will be defaults on prime mortgages.  Check.
• Consumer lending practice stupidity exposed.  Check.
• Recreational sector (boats, etc) smashed.  Check.
• Government will meddle.  Biggest check of all!
• Buffett will win on munis.  Miss - a clean miss.
• Equity prices will at least touch 1220, target of 1070, no surprise on a three-digit handle for the SPX.  Major check.
• Return of capital is the dominant theme.  Check; 0% IRX anyone?
• No "hyperinflation".  Check.
• Debt to be paid down and/or defaulted.  Half a check.  The hiding continues, and so far, there's no indication that the end of that rope has been reached.
• CRE will collapse.  GGP anyone?  Check.
• Business CapEx will go to hell.  Check.
• Dollar will strengthen. Check.
• Market callers coming to the public "hat in hand".  Nope; clean miss.  Where's Cramer committing Seppuku on national TV?  Oh well; hubris knows no boundaries.

16 predictions, two clean misses and one half-miss, the rest either panned out or were proved tremendously conservative.

That's not bad.  Anyone else got a public scorecard?  Cramer?  Kudlow?  How about Dickey Bove?  "Generational buy eh?  Hmmm....

Let's recap where we are today:

• Debt has risen at a faster rate than GDP for the last seven years.  This has led to a falsely-stated increase in GDP, in that when debt rises faster than GDP (on a percentage of GDP basis) what you're doing is financing expansion through debt that is not being paid down through production.  Due to the nature of interest, that being the compound nature of it, this constitutes a pseudo-Ponzi Scheme that must fail.  It now is failing, yet The Media continues to report falsehoods on exactly what is going on with households (and for that matter, businesses as well.)
• The Federal Reserve has continued to pump "liquidity" into the economy, which is their job, but they have also continued to cover up fraud and blatant thievery, which is antithetical to their role as the primary regulator of the banking system.  This is what Japan did, but they had savings to cushion the blow of their idiocy.  We do not - we only have debt.  Note that it did not work in Japan in that they have had below-trend growth for more than 10 years and now are facing a second, disastrous leg downward.  Why anyone thinks it will work here with a higher debt-to-GDP ratio defies logic - but this is the altar being prayed at.
• As The Federal Reserve and Treasury actions have proved inadequate they have continued to do the same thing but with ever-larger amounts of money that doesn't exist, committing to borrow ever-larger sums.  This simply accelerates the first problem.
• Neither Treasury or The Fed has a damn clue as to what they're doing.  The SEC's Chris Cox and various members of Congress have confirmed this repeatedly, stating clearly that both Bernanke and Paulson have come to them with demands for immediate action backed by outrageous claims of immediate collapse of the entire financial system, martial law or both if they do not acquiesce to their demands, even though less than a month prior (and for the previous year!) these same people were claiming that our economic issues were contained.  The only possible explanation for this behavior is that these two men were and are incompetent, insane, panicked and unable to think clearly, concerned that their complicity in this mess is about to be exposed (and it will end very badly for them) or all of the above.
• Many of the actions of both Treasury and The Fed are of questionable legality - at best.  The worst abuses include claims of "transparency" on the TARP that have simply not been met and The Fed creating over one trillion in new debt against the taxpayer without an authorizing bill in The House - a flatly unconstitutional act that in a true Constitutional Republic would have led to the immediate de-authorization of The Federal Reserve as the nation's monetary authority.  More recently Treasury has actually been kiting checks on the TARP (they have committed $10 billion more than authorized thus far); that's a criminal offense if you do it with your checking account.
• All of the above have taken what was a 10% correction in GDP that was necessary in 2000 (and which was primarily centered in businesses) and moved it to a nearly-30% correction in GDP that is now necessary.  If we continue down this path and actually spend all the so-called "committed" funds in 2009 as would be expected, the net contraction in GDP necessary to bring the system back into balance could reach 50%.  This level of contraction would be catastrophic and could easily threaten the political viability of our government, not to mention 30% of American jobs and incomes.
• President Obama has "threatened" to spend north of $1 trillion in "stimulus", but in fact the nation doesn't have that $1 trillion.  You cannot go further into debt to avoid the consequence that arises from excessive debt in the first place!  If President Obama does not realize this fact and change course before he (and Congress) spend this money the odds of that 50% contraction go up precipitously; the $1 trillion expenditure alone will "back load" yet another 5% onto the GDP contraction that must come.  This is an act of pure lunacy and yet it appears to be precisely what our government intends to do.
• The cockroaches have scurried as their cover is withdrawn (Buffett's "swimming naked" analogy) and this has continued apace all year, with the latest being Madoff.  We've developed a quite-impressive list of ignored warnings going back 20 years; subprime, banking "regulation", securities dealers running ponzi schemes and Treasury Secretaries lobbying hard (before becoming Treasury Secretary) for leverage limit removals that prove to be the trigger for the crisis.
• Madoff is not what it appears to be.  At best Madoff is a 20+ year scam that occurred with not only the intentional blindness of our government but its explicit assistance and cooperation.  It is simply not possible for one man to run a Ponzi Scheme of this size, sending out statements every month to hundreds if not thousands of clients and employing a group of people, moving this amount of money around, and have the entire thing be a scam without the cooperation of literally hundreds of accomplices including accomplices inside regulatory agencies and the government itself, along with regulated entities including the banks that lost money.  You cannot place that sort of capital as a bank or other regulated entity on nothing more than "trust" - no matter who its being placed with.  There is much, much more to this scandal and you can bet the people involved will do their level-best damndest to keep the truth from coming out.  Never mind the fact that explicit warnings were transmitted to the SEC.
• Job loss has risen and shows no sign of topping.  Don't expect it to any time soon.  Be aware that unemployment peaks after recovery is already well underway.  This makes unemployment a good indicator of misery but a horrible one for where we are in the economic cycle; as such looking for this to "bottom" is a terrible idea if you're an investor.
• The number of "bottom callers" have increased dramatically.  Don't believe it.  The S&P 500's forward earnings for next year is still estimated around $70 (!); that's lunacy.  The banking model for earnings is permanently broken and they will return (after washing out) to the "Grandfather's banking" sort of earnings - slow and steady with growth limited to that of GDP.  IMHO the S&P 500 will be lucky to post $50 in earnings for 2009.  Bear markets frequently bottom with a single digit P/E multiple, which puts the SPX at or under 500 before this is over.  We are still 40% overvalued by this metric!
• The 20/50W (and 13/34 EMA) timing signals are not only on a SELL from early 2008, they are still getting more divergent toward the sell side.  I will simply observe that those who try to be heros in the market often wind up with zeros in their account.  Until these timing signals flip the primary trend in the market is down.  This doesn't mean you can't make plenty of money trading bear-market rallies, but it does mean that if you're buying here "for the long haul" you are attempting to front-run a trend change that would be years away and another 50% - or more - below us in terms of price.  This market is not a falling knife - it is a falling chainsaw.

In short, essentially nothing positive has been done and a lot of damage has been inflicted on everyone in America out of hubris, fraud and avarice.

We now are "discovering" what I have written about for more than a year first-hand - the so-called "growth" over the last seven years has all been a fraud, instead being nothing more than additional debt.  Ponzi-finance has taken over every area of our economy, from government to private business, and has run to the natural limit of "the greater sucker", now leaving all of the people beguiled and bedeviled exposed as the naked-swimmers that they are.

There has been zero push for accountability and truth throughout the system.  Not among our so-called "leaders", not among the bankers, not among the political or economic elite.  All are focused on trying to keep the impossible going.

The truth of all of this is trivially easy for you to demonstrate to yourself.  Just ask the following questions:

• If you have $100,000 and borrow another $100,000, have you doubled your net worth, or have you actually harmed your economic position, as you will not only have to pay back the $100,000 you borrowed but also interest on that money?
• If you do not own a home, do you want that house to be priced high or low?
• If you want to buy a car, do you want the price on the car to be $20,000 or $40,000?
• If you're buying gasoline do you want it to cost $2 or $5 a gallon?
• Are you better off with zero credit card debt, $2,000 in credit card debt or $20,000 in credit card debt?
• How did we actually nominate a man for President of the United States (he lost by the way) who declared publicly that he had one half million dollars in credit card debt and couldn't tell a reporter how many houses he owned?
• How did we have a bill, the EESA/TARP that obligated citizens to pay $700 billion in taxes that we do not have (that is, to put us all in debt by another $700 billion), that was opposed from 100:1 to 300:1 in calls, faxes and letters to Congress, was passed over those objections with an election less than a month away, and we the people then returned 90% of those who voted "Yes" and stood for re-election to office?

There will be no improvement in the economic condition of our nation until each and every one of us ask ourselves these questions, honestly contemplate our answers, and then put our outrage (or desire) for those economic conditions into firm, no-nonsense peaceful action to force our elected and unelected government officials to act as we direct.

Please realize that if just one third of one percent of the population of America was to get upset enough with the blatant fraud, theft, Racketeering and Ponzi Finance that has literally decimated the economic structure of our nation, American households and our future (not to mention our children) and were to show up in Washington DC in peaceful protest, occupying The Mall, Constitution Avenue and surrounding areas and refused to leave until every one of these charlatans resigned in disgrace or committed seppuku on national TV the protesters would number one million. 

Such a mass of people would be literally impossible to refuse to answer to.  That we have not yet seen it simply means that the population of this nation either doesn't care that it is being systematically looted, is too full of Prozac to pay attention to the racketeering and theft or is simply not paying attention.  (My vote, by the way, goes to the latter - at least for now.)

Further, if we the people were to organize as few as one hundred individuals in each major city we could effectively slow commerce to the point that it would break down entirely, all through peaceful means.

How?  Envision your local freeway; you, and three of your friends (four lanes each way, four drivers) line up parallel and then slow to a crawl (if you're in "rush hour" traffic) or to 20mph if not.  Traffic would instantaneously snarl behind you and remain that way for hours.  Your risk?  A traffic ticket.  A few hundred dedicated people in each major city could very effectively demand that real reform take place and that all the fraudsters go to jail, refusing to stop their daily protest until it was done.  Again - a tiny fraction of one percent of the population of this nation could, through entirely-peaceful actions in protest, force a stop to this nonsense.

It hasn't happened.  Why not?  Are there not a few hundred unemployed as a consequence of this fraud in every major city across America?  Are we really all so neutered as Americans that we will refuse to peacefully protest in an effective manner?

You want to know why the fraudsters - including everyone screaming to be bailed out of their ill-conceived schemes - are winning? 

It is because Americans refuse to get off their ass, even though very effective and fully-peaceful means of demonstrating and demanding change - Constitutionally Protected means of expression that would have vast and immediate effect - exist. 

Simply put, we are consenting as individuals and a nation to the economic rape being served upon us by the scams and schemes of the few.

Now let's look at first principles when it comes to economics.  All of these are not desires, wishes or dreams - they are facts:

• Debt when used to "pull forward" future production into current spending can be useful (for example, the farmer who borrows to buy seed or the producer of goods who borrows to buy raw materials that then are made into finished goods.)  Debt taken to finance consumption has zero positive long-term impact on the economy. When debt is taken to pay existing debt it has the potential to result in catastrophic economic collapse.  The latter is what we have been doing for the last 30 years.
• You cannot solve an addiction problem with more of whatever the addict is hooked on, whether it be booze, crack, meth - or debt.
• Its not credit, its debt.  Stop listening to the BS handed out on CNBC and in the paper.  When someone you talk to says "credit" stop them right there and correct them.
• Our monetary system is debt based.  The more "liquidity" they pump (and even the more money they "print") the more debt is taken on.  Again - have you ever seen an addict cured by giving them more of their favored drug?  Is there any possibility that this "medicine" can actually work?  Simply put: NO.
• Debt is inherently deflationary. The inflationary impact of additional credit creation is temporary; in the longer run debt always has a deflationary impact.  This is obvious and inescapable if you use your head; since debt must be repaid with interest, it therefore must deflate (decrease) the monetary base since interest is a non-productive "charge" against income and (thus) earnings.  This, by the way, is the fatal flaw in Bernanke's Doctoral Thesis; by refusing to recognize that all modern monetary systems (including ours) are debt-based he also fails to recognize that there are limits to being able to "print" your way out of a deflation since what you are printing is in fact debt and eventually you reach an "inflection point" where the spiral tightens - that is, the more "printing" you do the worse the problem gets!
• If debt as a percentage of GDP is increasing then you are paying off debt with more debt and falsely stating GDP. This is obvious to any objective observer; a debt taken to buy a car shows up in "GDP" as the car must be produced but in fact the actual GDP impact of that transaction (over time) is negative as interest must be paid on the debt and the principal must be paid down.  In the converse if debt-to-GDP is shrinking then GDP is understated.  The true GDP number is only presented when the debt-to-GDP percentage is stable.  This is true for all debt-based monetary systems and cannot be changed by waving around magic Federal Reserve wands.
• We have been falsely claiming "growth" that did not actually occur for more than 20 years; this is why your wages have been stagnant while everything you need to buy has gone up in price and for most Americans their standard of living has contracted.

The above will not change until the Debt-To-GDP ratio begins to drop.

That cannot happen until The Government stops supporting the bankrupt with more and more bailouts and "stimulus" and instead forces those who can pay down their debt to do so along with forcing those who can't (the broke) into bankruptcy court where their debt is discharged.

The economic pain inherent in such a process cannot be avoided, it can only be delayed and with each delay the total damage that must be absorbed to restore balance to the economy grows.

We keep hearing so-called "pundits" talk about how "we must spend like mad or we will have a Depression."  Folks, that die was cast in 2001 when the decision to avoid a recession by pulling forward demand through excessive debt.  It is no longer possible to avoid the outcome, we can only choose when the outcome occurs, and the longer we wait to do it the worse it will be as a direct consequence of the fact that in all modern monetary systems money issued by the government is in fact debt and the problem is that we have too much debt already! 

FDR has been widely hailed as a hero.  He was no such thing.  FDR's policies in fact caused a second wave of depression after the original downdraft that originated in 1929.  This is not commonly reported but it is in fact true - there was a second, nearly 20% contraction in GDP that occurred as a direct consequence of FDR's policies.  Repeating what FDR did to any material degree will not help, and any apparent "relief" will be false.

In short, as pointed out in The Ticker of the 20th - We are all Madoff in one form or another.

Ok, so with that cheery backdrop, here you go with my predictions for 2009.... and I will prefix this by saying this is a list I hope proves to be entirely incorrect.  Perhaps there really is a Unicorn that craps skittles even though I've yet to find it - this is one round of predictions I'm willing to take a zero score on come December 09.

• The economy will not recover in 2009.  Job loss will continue through the year and unemployment will reach 8% in the "headline" statistic by the end of the year.  U-6 (broad unemployment, or the closest to "real" unemployment without government "cooking") will top 15%.  All the "talking heads" are predicting a turnaround in the second half of 2009.  They will be wrong.  Look at their records for 2008 - all of them were predicting closes at or above 1500 for the S&P 500.  Why does CNBC continue to put people on the air who, if you listened to them, cost you 40% or more of your money?
• Deflation, not inflation, will become evident well beyond housing.  Other capital goods beyond housing will see real price declines for the first time since the 1930s.  Debt is inherently deflationary; the "hyperinflationists" will once again be shown to be wrong (how many years running will it be now?)
• Housing prices will continue to decline.  I believe we're about halfway done with the price correction.  Those who think we will turn this in 2009 are wrong - unless we get an all-on collapse in prices in early 2009, which I do not believe will occur.  I've heard several claims we will have positive year-over-year home price changes in 2009.  I'll take the other side of that bet.
• The Fed's attempt to "pump liquidity" will be shown to be an abject failure.  We will see either a Treasury Market selloff or worse, severe instability in the dollar at some point in 2009.
• GDP will post a 12-month negative number and there is a decent shot that we will actually see an official depression print before the end of 2009, defined as a 10% decline peak-to-trough.
• The Stock Market has not bottomed although you may think it has for a few months. The annual range will be quite extreme; I would not be surprised at all to see 1,000 touched on the SPX in the first part of the year.  I believe the SPX will at least touch 500 in the next 12-24 months and the current bottom will not hold.  It is possible that we could see a crash to SPX 300 and DOW 3,000 some time this year, probably after the spring (when the "Obama Halo" wears off - if it isn't blown off by economic events first.)  Yes, this means I am predicting a fifty percent swing in the SPX in 2009.  Lots of money to be made as a trader if you're quick and good, but an absolute minefield if you're a long-term investor.
• Precious metals will not be a safe haven.  The callers for $1600 and above on gold will be wrong, unless there is a major military conflict.  I do not rate that probability as particularly high, but it is an event (along with a major terrorism incident - nuclear or biochemical - that would cause a rocket shot in Gold prices), so I am hedging that call.  The risk of this sort of "response" to the economic crisis is, however, real, and will rise significantly going into 2010 and beyond.  We'll revisit this one (a major war) next year.
• The Dollar will not collapse.  This is not because we're in great shape or will truly recover, it is because the rest of the world is in worse shape than we are.  Last year pundits were all calling for the dollar to collapse to 40 - it didn't happen.  Now they're calling the dollar's strength a "Bear market rally."  Nonsense; the simple truth is that while we're in bad shape the rest of the world is literally on the precipice of a full-on collapse.  European banks are more-levered and less-transparent than our banks as just one example.
• The pound or euro - and perhaps both - will likely be where the FX dislocation initiates if it occurs.  I see the potential for the pound and euro to both reach par with the dollar, although I'm not going to go that far out on the tree limb and predict it - yet.  Needless to say that would rocket the Dollar Index but it won't be our strength that does it - it will be their weakness.
• The US Consumer will go from a negative savings rate to a seriously-positive one. I am predicting 4% in 2009 but it could go as high as 10%.  The math on this is simple - the "consumerist legion of more" has run its course and all that's left is debt.  It hurts and bad; expecting the American Consumer to cut off his other arm is just plain dumb.  By the way this is a good thing in the longer term for America once the excess debt is forced out and defaulted through the system.
• Commercial Real Estate will effectively collapse and most commercial Real Estate REITs will be either insolvent or limping on life support.  There will be calls for bailouts (which may be attempted; the calls are already starting to be heard) but it won't matter - a failed business is a failed business, bailout or no, and overcapacity must go away before sustainable business conditions can return.
• Along with the above, expect 10% of all retail stores to close, and that number could go as high as 20%.  That's not going to be fun; there will be hundreds of malls that wind up literally shuttered across America.  Stay away from most retailers and property groups as investments.  Firms like SPG and VNO are levitating on the strength of their dividends (7-10% yields at present); I believe this is a sucker play; if retailer defaults force dividend cuts (and I believe they will) the commercial REITs will go straight into the toilet.
• Several states will get in serious financial trouble and outright default of one or more is possible in 2009.  California leads this parade.  But even if there is a default on a state basis, the effect will be highly localized, as county and municipal governments vary in their wisdom and budget process.  The real pain comes in state-wide social and educational programs.  Be very careful if you are in municipal bonds or thinking of getting back into them (I recommended they be dumped in 2007 - look at what has happened to the closed-end funds in 08!  Aieeee!) as the default risk is VERY REAL.  If you're buying individual issues and do the work to determine not only the risk of default but also the likely recovery if they do default there are some good deals out there - but only if you're doing the work.  "Trust me" (as in buying funds, whether mutual funds or closed-end stuff) is very dangerous.
• Mortgages are not done.  The story last year was "Subprime."  This year's will be "ALT-A", "Option ARMs" and so-called "Prime".  The Fed and Treasury know this, which is why they are playing games with "agency" debt in a desperate attempt to clear this market before the ticking nuclear devices go off.  The amount of debt involved in these "bad deals" is vastly higher than that in the "subprime" space and if they fail to contain it (a near certainty) Round #2 of severe bank instability gets served up on us in the second half of 2009.
• If you want to refinance a mortgage you may get one brief shot at it with long rates around 4%.  You're nuts to buy outright unless you intend to die in the home, but if you have a solid reason to be obtaining a mortgage or wish to refinance you will probably get the opportunity.  This assumes the "buydown game" gets going before Treasuries dislocate; if you get the opportunity take it as it is likely to be fleeting.  The few places in this country where homes wind up selling for 2.5x incomes (on average) and you have an opportunity to finance at 4% and change will be decent buying opportunities - if you're sure you can cash flow the note (e.g. your job and/or income stream is not in any danger of collapsing.)
• Those who have said that the corporate bond market is being "unreasonable" in its expectation for defaults will start to look like the jackasses they are.  Actual default rates (not projections) on non-investment-grade debt will skyrocket starting in 2009 and there will be no sign of it turning around this year.  If you're playing in this area of the market thinking that "the worst is behind us", I hope you like walking around bald as the haircuts handed out to folks like you will be especially severe and delivered with a straight razor.
• The calls for "more lending" to consumers and businesses will go exactly nowhere.  The problem isn't credit availability - there's plenty of money available to lend if you are credit-worthy.  Those who are being turned down now simply aren't credit-worthy when one looks at what they want to do with the money and what they're backing their repayment capacity with.  The more "credit stimulus" is thrown into the economy (and there will be more) the worse the downturn will get.
• General Motors and Chrysler will fail to meet their targets and it will be labor that sinks the deal.  At least one and probably both will wind up in some form of bankruptcy in 2009.  The UAW is insane; Gettlefinger needs to be strung up by his genitals and pelted with rotten tomatoes by his union "brothers", and if they had a lick of sense they'd have already done it.  They obviously don't.  I give this mess six months tops, with Ford as the only possible survivor.  The recent GMAC games show exactly how desperate they are; 0% 5 year loans to people with 620 FICO scores are flat-out insane and the default rates on those loans are going to wind up in economics textbooks five years hence.
• Protectionism and currency manipulation will rear their ugly heads in 2009, originating not here but in Asia as their economies go straight into the toilet.  China and Japan are at severe risk here.
• Commodities will appear to be headed for a new bull market but this will turn out to be a false hope as demand continues to collapse.  Attempts to manage oil output to prop up the price will fail.  Several oil-producing nations will find themselves in serious economic trouble, with Russia being in the lead but by no means alone.
• Sovereign debt defaults will number at least three with many other nations on "watch" for same; we had one last year (Iceland.)  Noise about a US "AAA" downgrade will continue.  Highest on the list for probables are Russia, which needs oil at roughly double its current price - and stable - to be financially viable.  Not going to happen in the near term.
• China will have its first large-scale rumbling of civil unrest as a consequence of collapsing export demand and thus employment.  They'll manage to tamp it down - this year.  Don't take a bet on that holding together longer-term.  Those who think China will be "ok" are deluded; they have a horrifying overcapacity problem (debt-financed, of course) and there is no way for them to get out of it.  They are truly going to "take it in both holes" down the road, but the worst of it won't be in 2009 - that is still a year or two in the future.
• Foreign uptake of Treasuries will be choked off - by necessity.  It won't be because they want to screw the US (although they should have a long time ago, given our profligate and unsustainable habits), it will be because they will be forced to redirect their resources inward as their own economies collapse.
• "The City" (London to be precise, Britain generally) will be recognized as getting it "worse than we are" (in America.)  This will be the first of many validations of my thesis "we're screwed, they're gang-raped."
• Things will get "revolting" in a number of nations.  Not here in America.  Yet.  If we're lucky the American Sheep will wake up and stage some of that peaceful protest stuff I outlined above.  If we're not so fortunate 2010 could be really bad.

In terms of recommendations its simple - rallies are to be sold, cash is to be raised and prudence is to be practiced in your own personal financial affairs.  Don't get creative in all things finance, get stingy and prudent.  Your personal financial survival could well depend on it.

Let's ask some "tough questions" here.

First, let's start with blank">The Fed's press release "filling in the details" of their intended purchase of Fannie and Freddie (along with Ginnie) securities:

"Only fixed-rate agency MBS securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae are eligible assets for the program."

Ok, so we claim these are the securities.  Well enough, so far.

"How will purchases under the agency MBS program be financed? Purchases will be financed through the creation of additional bank reserves."

That's FedSpeak for "we're going to print the money out of thin air."  In other words these purchases will be financed through taking on additional debt for which the US Taxpayer is obligated, since dollars are in fact debt and are backed by the "full faith and credit of The United States" (so it says - "This note is legal tender for all debts, public and private.")

Now what does The Constitution say about that?

"All bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as on other Bills."

What is a "revenue bill"?

Legally, it is a bill that obligates the taxpayer.  This is why the TARP/EESA had to be attached to existing legislation in The Senate - it was not Constitutional for The Senate to originate that bill (the Senate CAN originate other sorts of bills) because under The Constitution all revenue bills must originate in The House.  Because the EESA proposed to raise revenue (indirectly; it was a bill to spend and thus obligate the taxpayer for which revenue would have to be raised) it had to originate in The House of Representatives.

Thus the game-playing by the Senate, attaching it to an existing revenue bill (the "mental health" bill) that was languishing on The Senate floor.

Why is this important? 

Because The Fed's actions - all of them that in fact are "financed through the creation of new bank reserves" - are in fact unconstitutional unless explicitly authorized by a revenue bill originating in The House.

Second, we have this little problem:

"What is the legal basis for the agency MBS purchase program?Purchases of agency MBS in the open market, under the direction of the FOMC, are permitted under section 14(b) of the Federal Reserve Act."

Only for Ginnie Mae.

The specific section referenced, 14(b) of The Federal Reserve Act, says:

"Purchase and Sale of Obligations of United States, States, Counties, etc., and of Foreign Governments

(B)

1. To buy and sell, at home or abroad, bonds and notes of the United States, bonds issued under the provisions of subsection (c) of section 4 of the Home Owners' Loan Act of 1933, as amended, and having maturities from date of purchase of not exceeding six months, and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any State, county, district, political subdivision, or municipality in the continental United States, including irrigation, drainage and reclamation districts, and obligations of, or fully guaranteed as to principal and interest by, a foreign government or agency thereof, such purchases to be made in accordance with rules and regulations prescribed by the Board of Governors of the Federal Reserve System. Notwithstanding any other provision of this chapter, any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to the principal and interest may be bought and sold without regard to maturities but only in the open market.
2. To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.

Now here's the problem.

(B).1 clearly does not apply.  These notes have a maturity of more than six months.

(B).2 only applies to Ginnie Mae securities.  How do I know?  Because this is what is on the face of every Fannie and Freddie offering prospectus:

Every single prospectus for the various MBS and other offerings of Fannie and Freddie through the years - all of them - contain this language on the face of the prospectus.

This is what is on the face of a Ginnie Mae prospectus:

Any questions?

Fannie and Freddie, even in conservatorship, are still publicly traded companies.  Henry Paulson, Secretary of the Treasury, has been asked multiple times if these securities have been "converted" to "Full Faith and Credit" and he has refused to answer in the affirmative. 

Without some sort of enabling legislation (remember, Revenue Bills must originate in the house, and this would be the GrandPappy of all such bills, since the debt taken on would total five trillion dollars all at once), Fannie and Freddie debt cannot be converted to "Full Faith and Credit." 

Period.

This fact is why these securities trade at a significant spread to Treasuries; ergo, they are not full faith and credit obligations.

Paulson knows this, which is why despite repeated attempts he has refused to answer in the affirmative.  He'd love to say yes - but he can't and he knows it.

In fact, this is what Freddie's web page says directly to this point:

">6) Is Freddie Mac a government agency?

No. Freddie Mac was chartered by Congress as a private company serving a public purpose. On September 6, 2008, the Director of the Federal Housing Finance Agency (FHFA), appointed FHFA as conservator of Freddie Mac. As conservator, FHFA has all rights, titles, powers, and privileges of Freddie Mac, and of any stockholder, officer, or director of Freddie Mac with respect to Freddie Mac and its assets; and title to the books, records and assets of Freddie Mac. In connection with the appointment of FHFA as conservator, Freddie Mac and the U.S. Department of the Treasury have entered into a Senior Preferred Stock Purchase Agreement. As part of the agreement, Freddie Mac has issued $1 billion aggregate liquidation preference of senior preferred stock to Treasury, together with a warrant for the purchase of common stock representing 79.9% of Freddie Mac's common stock."

Ginnie Mae securities trade with much less of a spread; this is because they are issued with the full faith and credit of The United States behind them.

Again, the difference is clearly disclosed on the face page of the prospectus of all of the securities issued by each of these firms in accordance with securities laws of The United States.

Therefore, it appears to me that under the plain facts of the Statute and the US Constitution the actions that The Federal Reserve announced today are unlawful, constituting a direct violation of both statutory law and The United States Constitution, and that Congress and The Justice Department, both of whom are aware of these facts, are intentionally refusing to enforce both the Statute of The Federal Reserve Act and The Constitution.

This action is not of minor importance and the amount of money involved is not "de-minimus."  $500 billion dollars is approximately one sixth of the entire FY2008 Federal Budget and has been effectively expropriated without an act of Congressional authorization originating in The House.

I ask again:

Is there a Federal Prosecutor who still believes in The Constitution and Rule of Law who will go after this issue, and if not, is there any other person or group of persons who has sworn an oath to uphold The United States Constitution left in this nation who will actually  discharge that obligation?

If so when will Chairman Bernanke be removed from office and these decisions reversed?

(PS: I doubt that such a person or group of persons still exist in America, despite what they may say - but I had to ask)

For this year.

"The company said it won’t finance “higher-risk transactions,” instead concentrating on prime customers who are more likely to repay using “responsible credit standards.” The relaxed policy “will allow us to return to more normal levels of financing volume, and should help in efforts to stabilize the U.S. auto industry,” GMAC President Bill Muir said in today’s statement."

Ok.

What constitutes a "prime" customer?  This means that only the best credit risks will get financed at a reasonable rate, right?

Uh, no.

GMAC reduced the credit score necessary to get a loan from 700 (very good) to 621 (not very good.)

The median (average) FICO score in the United States is (according to myfico.com) 723.  That makes 621 quite crappy.

Worse, here was what GMAC did:

"Within hours, GM was offering no-interest loans for as long as five years to counter this year’s 22 percent drop in sales, caused in part by the inability of its customers to get financing."

Oh, and the terms? 

"GMAC will pay an 8 percent dividend on the Treasury’s $5 billion of senior preferred equity. The company will also issue warrants in the form of additional preferred equity that will equal 5 percent of the preferred-stock purchase and pay a 9 percent dividend if exercised."

So let me see if I understand this.

The government "buys" preferred equity that pays an 8% coupon.  GMAC must pay that 8% coupon (9% if the government exercises the warrants)

GMAC turns around and loans out money at 0% which it has to pay 8% to acquire, and at the same time decides that it will make loans to people with credit scores significantly worse than average, when before they would make loans only to people with scores that were slightly better than average.

And we wonder how we got into this mess?

Loaning money out at a lower rate of return than it costs you to acquire - isn't that kind of like "we'll lose something on each sale, but make it up on volume?"

Oh, and then while we're at it, let's make lots of loans to people who have credit significantly worse than the average credit score in the United States, instead of just making loans to those who are at least average in their handling of credit.

The Federal Reserve approved GMAC's bank holding company application with this as the background and without constraint to prevent this intentionally-losing strategy from being conducted.

In one sentence:

The Federal Reserve and Treasury approved an application that contained as it's essence an intentional money-losing business strategy, enabling the literal looting of the public treasury under the false pretense of an "investment".

If you wonder why our nation is absolutely, totally screwed, and why we will see 2009 bring us ever-closer to an economic collapse as the pyramid of bad debt, intentionally taken on with the full knowledge and complicity of Treasury and The Federal Reserve collapses, you need look no further than this announcement.

Bernanke and the entire Federal Reserve Board of Governors, along with Paulson, need to be removed from office for intentional dereliction of duty.

PS: I thought TARP V1 was out of money..... Is Treasury kiting checks?

That has gone "just below" 1.0.

What is this?

I could go through the derivation of how money supply works in a fractional reserve monetary system (any), but won't, because most readers would have their eyes glaze over.

The important part of this graph is what it denotes.  Bernanke has lost control of "N" (or velocity), which is the actual knob that he is trying to diddle when borrowing rates are changed (and in fact its the market that sets that, despite his protests.)

In fact the most useful tool in The Fed's box in terms of influencing monetary policy is the soapbox, that is, jawboning (whether it be by cajoling or threatening.)

The problem with an M1 multiplier below one is that the effect of printing money is of course multiplied by the velocity.  That is, if you print up $10 into the economy the impact it has on economic activity depends on how many times that $10 circulates in a given amount of time.  The more it circulates the higher the impact and the more your efforts do for the economy.

The bad news is that when the multiplier is less than one the more money you spew into the economy the worse the impact, as you get less for each additional dollar.

If you remember the "GDP for each dollar of debt" graph....

M1's multiplier going below 1 strongly implies (but does not yet prove) that we have reached that "zero hour".

Why?  Because all money is in fact debt; this is inherent in all modern monetary systems. 

When Bernanke "creates" money he is doing so against an asset - that is, he is issuing debt.  A Federal Reserve Note (whether electronic or paper) is in fact effectively a bond of zero maturity and indefinite expiration against the future tax collection capacity of The United States.

That is, it's a treasury bond (via a circuitous route)

The paradox that Bernanke is in danger of discovering (the hard way) is the paradox of a pilot who finds himself in a flat spin.  As the ground approaches he wants to pull back on the stick but if he does so, the spin simply tightens as the wings are not producing lift - the angle of attack is too high, not too low.  As such if he does what his brain screams at him to do instinctively, he dies.

Or the scuba diver who sucks on the reg and gets nothing.  Your instinct is to hold your breath and kick for the surface.  If you do it you die.

In both cases your only hope of survival is to do exactly the opposite of your instinct.  In the case of the pilot you must not only give counter-rudder (to stop the rotation) but also push the stick forward.  In the case of the diver you must exhale that last breath you have in your lungs, knowing there are no more in the tank while you kick to ascend. 

If you succumb to instinct you are dead.  Really dead, as in splat (or exploded lungs.)

Bernanke is effectively in the same box.  The foundation of his entire thesis as a banker is that a central bank can always reverse a deflation by printing money.  Unfortunately as he has done so velocity has fallen and the multiplier has now gone below 1.  If this induces him to do even more of what caused this decrease there is a very real risk that the actual market reaction will be to tighten the monetary flat spin.

This is because the underlying problem in the economy isn't the lack of debt (money) in the system.  It is that there is too much debt of all sorts, and since money is in fact a form of debt, you can't fix the problem by playing helicopter drop!

As I have said for more than a year the only way out is to force the bad debt out into the open and default it.  Yes, this will produce bankruptcies - lots of them, including some for "inconvenient" people like Paulson's buddies on Wall Street.

But until and unless that happens adding more debt to the system depresses the multiplier effect of that debt on circulation further, and harms, rather than helps the situation.

I don't expect our government officials to understand the math on this, nor would trying to go through it help 99% of the readers, but unfortunately, mathematics is the only true science - and you can't twist it, no matter how hard you try.

Bernanke knows this at an intellectual level, just as the diver - or pilot - knows that if he holds his breath (or pulls the stick) he is going to die.

The question now becomes whether Bernanke can overcome not only instinct but also political pressure to do the wrong thing and instead use his intellect - and the math - to do the right thing.

What is the right thing?  Paradoxially, it is to withdraw liquidity and by doing so force the bad debt into the open where it does (and must) default.

How far can the above ratio contract before we cross an "event horizon" from which there is no escape? 

I don't know.

But I do know that there is a "too late" point, as there is for all such things, and that we are approaching it, as I have been saying for months.

BTW, evidence that Bernanke's Monetary Flat Spin is already impacting the economy in ways that may do critical (if not fatal) damage was found this morning in the Case-Schiller numbers.  Everyone, including Bernanke, was expecting the rate of home price declines to start to slow in the second half of the year.  Instead, they accelerated.

We're in uncharted territory folks, and the forecast is for dark-and-stinky storms.

Buckle up.

PS: Congress, and the rest of America, can't say they weren't warned.  They were - right here.

I know, I know, Laura Bush says it wasn't.

Laura, like Condi Rice, is defining this in terms of foreign policy - that the terrorists didn't "win" after 9/11.

Or did they?

Was Bin Laden's attack intended to destroy us militarily?  Obviously not - two of his four planes that went somewhere were aimed at financial targets, not military or political ones.

Here's reality folks - Bush's Presidency is a failure not because he went into Iraq, not because he went after Afghanistan, and not because he set up a grand new Department of Homeland Security who's greatest achievement is forcing everyone to remove their shoes when going through airport security, never mind disallowing me from carrying on a tube of toothpaste in my handbag.

No, Bush's Presidency is a failure because he utterly failed to crack down on the financial fraud that was rampant in the Internet age and in fact not only turned a blind eye to it but appointed people to high office (Paulson and Bernanke, for example) who were complicit in the excesses and scams of that era and egged them - and everyone else - on into a credit-induced orgy that now has led to the biggest economic crisis since The Panic of 1873.

The responsibility for that is squarely and exclusively his.

Clinton handed Bush a recession, but Bush himself turned it into a Depression.

By taking his advice from the fraudsters himself he has corrupted his Presidency beyond repair and redemption.

That's a fact - one that historians will recognize in the fullness of time - and it won't be due to his foreign policy, but rather due to his domestic economic policy that was and is laced with fraud, theft and intentional deception.

PS: Obama looks to be headed toward doing the exact same thing.  Hoover #1 and #2?  We'll see.

President-Elect Obama hasn't asked, but I'm going to offer up my suggestions for the first 100 days of his Presidency anyway, with full knowledge that I have about as much of a chance of winning the Lotto as seeing them.

Nonetheless, here it is:

All "BS games" in both Washington and Wall Street must end immediately.  Not in six months, not in a year, not in two.  On January 21st.  By executive order if necessary, you simply must force the truth to be told by every firm up and down Wall Street and every department in Washington DC.  We do not have an economic crisis - we have a trust crisis - there is effectively none anywhere in either our Capital Markets or Washington.  The bleeding in our markets will not stop until this problem is resolved.

This is on your back, like it or not, and your first 100 days in office will define whether trust begins to be restored or is totally destroyed.  Thus far your cabinet appointments are all being seen as "more of the same" by those on both Wall Street and internationally.  You must prove that this is not going to be the case and do so quickly or the meltdown that we will experience shortly thereafter will make this last September and October look like a Girl Scout picnic.

Specifically, the following has to happen:

• Immediately investigate Hank Paulson, focusing on his 2000 and 2004 "requests" to remove leverage limits and his firm shorting the bonds they were selling to investors.  Conflict of interest or something even more evil?  The fact is that every firm that has collapsed has had more than double the former leverage limit that was imposed on investment banks.  All of them.
• Immediately investigate the OTS (and OCC) to determine how it is that people involved in the S&L scandal remained employed rather than being indicted and jailed.  We need answers on that issue given the IndyMac mess and revelations in this regard.
• Each and every individual and firm involved in the blatant, rampant fraud that allowed the housing and mortgage bubble to occur needs to be prosecuted.  No exceptions.  Since this will involve locking up tens of thousands of people, including mortgage brokers, realtors, appraisers and bankers, and we seem to be a bit short on jail space, I recommend commuting the sentences of and releasing all non-violent "consensual adult" drug offenders.  That should create plenty of room for the new inmates.
• Appoint a cadre of special prosecutors with power to subpoena every hedge fund and broker-dealer on Wall Street to ferret out the other Madoff's out there - jail them all.  There is never only one cockroach.  Never.  Oh, and while we're at it we need to guarantee that everyone involved in the Madoff mess goes to prison, including people in the SEC who were complicit in this scam.  Nobody pulls something like this for 20 years, at this magnitude, on their own.  That's impossible, and by the way, lying to the FBI to conceal a conspiracy is its own felony and should get Madoff a Racketeering indictment on top of the rest (along with his other co-conspirators.)
• Force changes in the bond ratings agency game.  No more "pay to play", otherwise known as "issuer pays" - at all.  Further, bar by statute the "opinion" exemption; you want what amounts to near-monopoly access to publish these opinions, protected by law, you should be held responsible for gross errors.  While one AAA bond that defaults isn't a gross error, when 75% of the bonds you issue an "AAA" on in a given asset class wind up non-investment-grade within five years you've not made an "honest mistake"; you're either grossly negligent or crooked.
• Tell the truth about debt in this country and how we got here.  You can't fix an alcoholic's booze problem with a bottle of whiskey; making him drunk again to stop the DTs eventually will kill him.  Such it is with debt.  We must force the excess, unpayable debt to default, no matter how painful it is, to clear the market.
• Stop trying to support home prices.  The solution to the housing mess is in fact found in the exact opposite policy - correction to affordable levels nationally.  That's no more than 2.5-3x incomes, on average.  Yes, it will suck.  We get that - it already sucks.  At the same time we need to stop building new houses until the existing inventory clears.  There's no need to mandate this - just refuse to provide any sort of artificial support or help for the builders; some of them need to go bust, and they will if we quit screwing around.  Capacity must come down.
• Force The Fed to disclose every asset it has purchased, and disclose every action Treasury has taken.  One Executive Order takes care of both.  This is our money, not theirs.  Act like the Oath of Office and Constitution mean something.
• Revoke the EESA/TARP.  You can send a bill up to The House to revoke it.  Do so.  If we have insolvent big banks then instead use the remaining $350 billion to charter 10 new banks and immediately IPO them off to the public.  This would support three and one half trillion dollars in lending, present nearly zero risk to taxpayers, might earn them a profit, and would provide support for the system as opposed to providing support to the fraudsters and ripoff artists who caused this mess.  Mandate that every transaction that these new banks engage in is 100% public - complete, open book - until the entirety of that seed capital is replaced.  Trust me - it will be, and fast, considering that these institutions will begin with zero debt and zero crap on their balance sheets.
• Send up a bill to re-institute Glass-Steagall in its entirety.  All the "investment banks" are now bank holding companies.  Good.  This will force them to spin off their commercial bank holding companies and spit out their "investment banking" and "broker/dealer" operations into separate firms immediately.  Glass-Steagall was the right medicine and we need it once again.
• Enforce by executive order, immediately, 12:1 leverage limits via the SEC.  You control the SEC now.  Make it happen on January 21st.
• Send up a bill to make the use of off-balance-sheet games a federal offense punishable by forfeiture of the entirety of any asset so concealed.  That will end that.  We should have learned from ENRON, and the lesson should not be "how to screw the public and government."
• Send up yet another bill to mandate that any public firm that uses any modeling for asset values must expose the full details of all ingested data and all algorithms to the public.  Any firm that wants to claim a "mark to model", in short, must allow any interested party to replicate how they arrived at that valuation.  No exceptions.

If - and only if - you, President-Elect Obama, are interested in the recovery of our capital markets and restoring trust in them, you will do all of the above.

If you do not then you will have demonstrated that you have zero interest in restoring trust in our capital markets and the market will in fact not clear and recover.

We are at an inflection point - and an extremely dangerous place for America. 

If we fail to deal with the underlying issues that have destroyed trust in our markets we will see capital flee to those places where the rule of law matters, where fair dealing counts for something, and where people cannot run $50 billion dollar scams for more than 20 years with the open and blatant complicity of members of the government.

You