The Market Ticker

Hmmm... Do We Need To Guillotine The WTO?

nospam@example.com (Karl Denninger) — Mon, 08 Feb 2010 09:59:00 -0500

That sounds dramatic - even drastic.

But is it?

There's an argument raised over at "Washington's Blog" that the real cause of all the financial problems -the global mess - is the WTO:

On March 1, 1999, countries accounting for more than 90 per cent of the global financial services market signed onto the World Trade Organization's Financial Services Agreement (FSA). By signing the FSA, they committed to deregulate their financial markets.

But let's be straight here.

"Deregulate" does not give license to fraud, even though there are some who would argue otherwise.

The root issue with all of these "financial products" is that they are unmarketable unless someone lies.

You can't sell a "structured product" comprised of liar loans if you're honest about the "qualifications" (or rather, the lack thereof) of the borrowers at anything approaching a profitable rate of return. Nobody will buy.

With honest ratings a CDS + Bond will always yield less than the risk-free rate of return. This is because nobody works for free, and the more complex something is, the more it costs.

These are facts, not suppositions.

So WTO or no WTO, without willful blindness toward fraudulent practices the market will take care of the scoundrels. Without the ability to lie - that is, if we simply lock up all those who misrepresent credit quality the liar loan + CDS will yield less than a Treasury of equivalent duration, and as a consequence the purveyor of those liar loans will have to price them at a rate that accurately reflects their risk of default (plus his profit.)

This instantly cuts the BS.

Yes, we could simply tell the WTO to get stuffed, and I can make a cogent argument that we should - for a number of reasons, not the least of which is that "free trade" doesn't make allowance for those working under literal (or near-literal) slave conditions, such as Chinese and Vietnamese workers who are working under effective conditions of indentured servitude and lack the human and labor rights protections we enjoy in civilized nations. "Competing" with a labor source that effectively has a gun in its mouth is not only impossible, the concept is idiotic on its face.

But that's irrelevant to the argument that "we were forced by treaty to deregulate." Among other things deregulation does not mean legalizing fraud and never has.

Second, the WTO's "FSA" appears to have never been sent to Congress and thus has no force of law as a treaty. It is a mere "suggestion" - and one that Congress has every right to ignore, as do our regulators, as under The Constitution all Treaties must be ratified by The Senate - without that consent any purported "international agreement" is of no legal force whatsoever. Treaties cannot be amended once voted upon without being subjected to a second vote (and possible refusal); the FSA was an amendment to an existing treaty, and thus without being considered by The Senate is a nullity in terms of actual United States obligations.

The "globalists" (and scaremongers who believe we have sold out to them) would have you believe that we have somehow obligated ourselves. This is false. We have done no such thing, and whether our government has complied with these wishes (some would say demands) out of a desire to appease those who have bribed legislators with million in campaign contributions the fact remains that when it comes to legal force of law in this regard there is none.

This, by the way, includes the WTO, which has a nice list including the US on the web page referenced above. That too is, as far as I can determine, a lie as the FSA was never put to Senate Ratification, and without that having occurred it is legally void, whether the WTO likes it or not.

(PS: For those who wish to argue that the Republicans are to blame for all of the world's ills, you should look into who was President when the negotiations took place on the predicate parts of the treaty that was ratified prior to the FSA "add-on" that has no force of law. Hint: He tried to hide what he had spilled on a particular blue dress.)

Toward Simplicity In Financial Markets

nospam@example.com (Karl Denninger) — Mon, 08 Feb 2010 08:31:00 -0500

We heard all about "intermediation" as if it was some form of god-hood in the financial markets. Is it really a chimera - or even a fraud? We'll take a close look at what banking really is (and is not) and explore what we should - and should not - have in our markets.

Join us at 3:30 Central today, Monday the 8th at http://blogtalkradio.com/marketticker for a lively discussion.

The Peter Principle Lives On (CIT/Thain)

nospam@example.com (Karl Denninger) — Mon, 08 Feb 2010 08:09:00 -0500

They can't possibly be serious....

Feb. 7 (Bloomberg) -- John Thain, the ousted chief of Merrill Lynch & Co., was named to lead CIT Group Inc., the commercial lender that emerged from bankruptcy in December, after a nearly four-month search for a replacement.

Oh, they are serious.

The same John Thain that ran Merrill into the ground with, in part, basis trades (that is, proprietary trading) that blew up in his face? The same John Thain who failed to rein in his prop desk's "geniuses" and was ultimately forced to sell the company to Bank of America? The same John Thain who didn't know how much exposure he had on (otherwise the detonation wouldn't have happened, natch.)

So now Thain gets to run CIT, a company that is shut out of commercial paper market (because it is still on life support) - a firm that had as its core business factoring receivables (which is an idiotic thing for a small business to do, but when you're playing the leverage game this is just one small part of it) and was making nice money at it until it got seduced by subprime lending and the "great spreads" that could be "earned" there.

CIT, of course, didn't figure out that the reason for the "great spreads" was that the people borrowing the money didn't have the ability to pay, and thus those "great spreads" would blow up in their face. Just like Merrill didn't think there was much risk in the "great spreads" they were getting on those basis trades.

The company has been trying to move its small-business lending, trade finance and U.S. vendor finance operations to CIT’s Salt Lake City-based banking unit so it can use deposits as a source of cheaper funding for loans.

That sounds like an awesome idea! Why don't we lend to small businesses with no collateral using our retail banking deposits!

What could possibly go wrong with that plan?

Of course they have to get the FDIC to lift this pesky cease-and-desist order they slapped on the bank first. That could be a small problem.

Only in America can you lose $27.6 billion along with effectively getting fired as your firm is forced into a shotgun marriage and be rewarded with another CEO position. Oh, and let's not forget the $1.2 million Thain spent on his office at Merrill too - while the firm was losing money.

The Peter Principle is alive and well.

Bernanke And Paulson Are Free?

nospam@example.com (Karl Denninger) — Sun, 07 Feb 2010 18:08:00 -0500

Lewis' "legal team" (maybe Ken Lewis himself) has apparently said:

"If this thing goes to trial you can expect both Paulson and Bernanke to be on the witness list." If he's going down, he's bringing them down, too.

Please?

Paulson and Bernanke in the dock? That's worth a Youtube. Or a dozen Youtubes, especially if they get fitted for orange jumpsuits.

And let me be clear: I believe they should be. Arm-twisting is one thing, but I suspect there's more than enough dirt to fit these guys (and probably Geithner too) for an "orange blossom special."

If this is Cuomo's strategy - charge Lewis and roll him to get to people higher up - it works for me, irrespective of whether it happens by Lewis rolling over or whether we do it the old-fashioned way - Lewis subpoenas them as hostile witnesses.

Either way I'll take it, and if that's what we have to do to find some justice in this whole sordid mess all I can say is "it's about damn time."

You Had Better Cage The Monster CONgress (AIG/GS/CDS)

nospam@example.com (Karl Denninger) — Sat, 06 Feb 2010 21:56:00 -0500

I've been writing about this now over a year in regard to the mess that became of AIG, their "financial products" unit, and what I believe is culpability not only of certain financial parties but more importantly our regulators of these firms.

Now The NY Times has published a new article that makes clear that my clarion call for major changes in these areas of the market were not only spot-on, but are even more necessary today than they were back then.

A.I.G. had long insured complex mortgage securities owned by Goldman and other firms against possible defaults. With the housing crisis deepening, A.I.G., once the world’s biggest insurer, had already paid Goldman $2 billion to cover losses the bank said it might suffer.

A.I.G. executives wanted some of its money back, insisting that Goldman — like a homeowner overestimating the damages in a storm to get a bigger insurance payment — had inflated the potential losses. Goldman countered that it was owed even more, while also resisting consulting with third parties to help estimate a value for the securities.

Read that carefully. The NY Times is making this sound like AIG had insured losses against securities Goldman was holding. That's what insurance is, right?

Here's the problem: Goldman didn't own the securities.

In addition to offering to cancel its own contracts, Goldman offered to buy all of the insurance A.I.G. had written for several other banks at severely distressed prices, according to three people briefed on the discussions.

Negotiating with Goldman to void the A.I.G. insurance was especially difficult, Federal Reserve Board documents show, because the firm did not own the underlying bonds. As a result, Goldman had little incentive to compromise.

Now do you see the outrage in these so-called "protection devices"?

They aren't. They were raw bets. Very highly-leveraged gambling instruments that had a very low cost at origination - a cost all out of proportion to their eventual potential return.

We do not let "just anyone" buy insurance. You must have an insurable interest. That is, I can't buy fire insurance on your house. If I could, I might - and so might 20 of my best friends. We might even target those homes we think might have fires. We could even bribe the folks doing a controlled burn nearby to be a little less careful than they ordinarily would. Or, in the extreme case, one of us might just set a fire on purpose!

None of this is allowed in the insurance marketplace because it creates too many incentives for people to set fires and otherwise cause calamities, whether through outright unlawful conduct or helping along "a series of unfortunate events."

In the regulated options, futures and stock markets we have controls on this sort of thing as well. To short a stock (legally) you have to be able to borrow it. That is, someone who owns it must lend it to you first (perhaps in exchange for money.) As more people short the cache of people willing to lend out that stock for free will evaporate, and you'll have to start paying up for the privilege of borrowing it. This is a natural check and balance on placing negative bets via shorting.

Buying PUTs or transacting in the futures market has costs too. Those regulated markets have defined margin requirements and they are enforced - nightly. The cost of buying a PUT includes something for the guy who sells it to you, as he is going to hedge his bet by being short the stock. Thus, as the number of PUT buyers increases the premium demanded rises - precipitously so as the demand for those PUTs goes up. Finally, buying a PUT doesn't come with the right to demand anything more from the seller - his margin requirements are enforced by the exchange and you don't get to hold the money.

These OTC CDS contracts had another insidious feature: They apparently included a clause that not only would a downgrade of the security trigger margin requirements but so would a downgrade of AIG.

The terms, described by several A.I.G. trading partners, stated that A.I.G. would post payments under two or three circumstances: if mortgage bonds were downgraded, if they were deemed to have lost value, or if A.I.G.’s own credit rating was downgraded.

The perversity of incentives here is that if you can demand that your counterparty hand over more and more "margin" to you it is possible to actually force a downgrade by your actions and thus cause even more margin to have to be posted! This, of course, harms the firm's liquidity and makes a further downgrade more likely.

Rinse and repeat to destruction - which, incidentally, is exactly what happened.

This is dramatically different than the regulated markets, where valuations are determined by the market, not by one of the parties at interest and the margin requirement is fixed by the deficiency (if any) against the final strike price and the market's price - the person who happens to be short gets no benefit (or harm) due to his or her credit rating. If you're underwater, you post margin. If not, you don't, but in neither case does the person on the other side of the trade get to hold the margin funds! He gets your money only when he closes his position or the option expires (if it's in the money.)

These "synthetics" (such as the Abacus CDOs) are an outrage on their face. These are not created from the purchase of actual physical asset (e.g. a mortgage security) but rather by someone writing a credit-default swap against a reference. These are then bundled up and sold. When a credit-default swap is then written against a synthetic CDO it is equivalent to writing a gambling contract on a gambling contract as nobody in the chain owns an actual physical asset (such as a loan)!

The simple fact of the matter is that "naked" CDS exposures need to be prohibited right now. They never should have been allowed and not a damn thing has changed. Purely synthetic instruments need to be traded on an exchange in each and every case as a means of preventing chicanery, where margin can be enforced transparently on a nightly basis by a neutral third party in the middle of all transactions - the nominal buyer for every seller, and seller for every buyer. This third party (the exchange), having no skin in the game either way, will not permit the abuses that are too easily committed when you have over-the-counter transactions of this type.

The article referenced makes a decent case that AIG didn't fall off the cliff, it was pushed. There are even allegations raised of collusive conduct which, if true, add an even more serious angle to this entire story.

But at the end of the day the problem boils down to the same basic facts I have been harping on since the beginning:

Writing "insurance" on something the purchaser doesn't own isn't insurance, it's a gambling contract.
When such gambling contracts stack up to a great degree there are huge incentives for someone to commit financial arson. Whether they did or did not is a matter for debate, but that the incentives exist to structure deals in a way that are easily detonated so you can profit from them as exposure increases is not open to debate. Such incentive does absolutely exist - and we must eradicate it.
To prevent fraud and gaming of the system, such contracts must be on a regulated exchange where each buyer and seller deals with a neutral third party (the exchange itself) that is responsible for nightly margining, trade reporting, open interest and bid/offer maintenance. These facts must be exposed at all times to the public so that the market operates in a transparent fashion and neither side of the transaction can be "pushed".
The exposure of these contracts on said exchange will also prevent disasters like AIG from occurring, as the fact that they are short "X" will become instantly visible to everyone, including their regulators. The precise exposure they are taking on will thus be known at all times.
We must bar backstopped entities (such as banks and insurance companies) from trading in or creating synthetic instruments such as this in the first place. These are not hedges as by definition there are no actual hard assets behind them. The argument that they are created to fill a demand from the market is true but irrelevant - the fact remains that with no actual hard asset acquisition behind them they serve no fundamental credit intermediation purpose which is the purview of banks and insurance companies - they are, instead, pure speculative instruments. Let the hedge funds, operating without any sort of financial backstop, create these all they want - and trade them on a regulated exchange - but keep the banks and insurance companies out of it.

We have not neutered this monster in the slightest. Indeed, the latest rabble in the market with regard to Greece, Spain and Portugal is, not surprisingly, about (once again) credit default swaps blowing out.

And again I ask - who wrote those CDS naked on these nations to people who didn't actually hold underlying positions in the bonds without them being traded on a central exchange, and why, after 2008 and 2009, do we still let that crap go on?

More Bleating: Small Business Loans

nospam@example.com (Karl Denninger) — Sat, 06 Feb 2010 17:57:00 -0500

Here comes the whines - once again - on small business lending:

WASHINGTON—U.S. regulators Friday urged banks to continue lending to credit-worthy small businesses, responding to growing criticism from Capitol Hill and the White House that regulators' aggressive post-crisis supervision is cutting off credit.

The Federal Reserve, Federal Deposit Insurance Corp. and other state and federal regulators in a joint statement said they were concerned about the contraction in lending to small businesses as banks respond to the financial crisis by tightening lending standards.

I can speak to this because, well, through most of my adult life I've operated and owned a small business in some form or fashion.

When I was in my 20s I formed Macro Computer Solutions, Inc. A subchapter S corporation that had two owners and shareholders, it was the prototypical "small business." We did data wiring, consulting work of various sorts and sold white-box PCs to local businesses in Chicago - including a firm that was later acquired by Waste Management.

It was a decent living, but a hard-working one. Neither of the principals (myself included) had much. I had almost nothing - literally. A paid-for car, some personal possessions, a few thousand in savings. That's all. The other guy had a house with a big fat note on it, a couple of cars, some personal possessions, a wife and a dog. Really.

Regular guys trying to make it all work.

Loans? You're kidding, right? With what for collateral?

Eventually we split up the company and closed it. I went to work for a Fortune 50, he went to work for a large national association, both doing what we knew how to do. We didn't close because we were forced out, but rather because we were made better offers for our time.

The name (Macro Computer) was one of the things I got to "keep" when we split things up. It later was re-filed first as a DBA and then as an S-corporation, later converted to a "C". That incarnation of the firm - with myself as the controlling shareholder - was the one that operated MCSNet, the Internet provider.

A couple of times I went to talk to banks about loans. But once again, I didn't have a lot in the way of assets. Oh sure, I had the company, and it had receivables and assets, but I didn't personally have much. Certainly I didn't have $100,000, $500,000 or $1m in "home equity" that I could pledge - I was a renter for a good part of my time as a CEO. I had some cash, but cash can be spent quickly, right? I might want a new boat, or an expensive car. Who could possibly know?

What was the answer to my inquiries? Simple:

And why wouldn't it be? Remember, lending - sound lending - is based on the "C"s: Capacity, Character, Collateral, Capital and Conditions.

I had capacity, economic conditions were good, and my character was fine - I had no record of screwing people over and my credit record was excellent.

But I lacked both collateral and capital personally, and if the business had the capital why would it need the loan?

What's being asked for here is for lending institutions to dispense with the 5Cs of credit and instead write loans based on phantom collateral and absent capital.

Let's face it - if the principals of the business have the capital or collateral why don't they take out the loan in their own name or loan the business their capital (at interest) and bear the risk?

The answer to that is obvious, isn't it?

Later in the 1990s of course people were falling over themselves to lend me money with no capital or collateral required. Lucent offered to "sell" me literal millions worth of telephone and data switching equipment "on credit" either as a capitalized lease or on a "payment plan" that was effectively zero-interest. Guess what? It destroyed them when those loans to businesspeople that never should have gotten them blew up in their face.

I learned an important lesson from all this in the late 1980s and 1990s - you don't really need loans to set up and operate a small business. You need guts and the willingness to work long hours and take risk. Personally. Yes, you'll grow slower. So? You'll own what you earn - it will be yours, not the bank's. You'll keep your opportunities to yourself, instead of always looking over your shoulder. And when the time comes to expand, whether it be by buying more stuff, adding employees or moving to a new, larger location you'll do it based on cash flow, not on whether you can make the minimum payment on some note and pray that you'll be able to roll it over at reasonable interest rates in a year or two.

Folks, this bleating is backwards.

I ran businesses in multiple areas of operation for more than a decade and never once did I take a bank loan. We paid people out of our business checking account, we had normal Net 30 commercial credit terms with suppliers, and we invoiced people we did work for. Yes, there were times that the checkbook was lean - very lean - and a few during which I wondered if we'd make payroll. But we did it, and when MCSNet really took off it meant that instead of being a slave to some banker behind a desk, I ran the place the way I thought it should be run, I made expansion plans based on what I believed to be reasonably-attainable goals, and I bought hardware with my checkbook instead of trying to figure out whether I could make payments factored by "growth rates" based on some fantasy.

This bleating from places like The Wall Street Journal and the crackpots of advocacy is misplaced. If you're a small businessperson and you can't make a go of it without unsound loans - that is, loans made without full regard to the 5Cs - then you shouldn't get the loan. Most of you shouldn't take the loan whether you can get it or not - the interest costs are just a millstone around your neck that will restrain both your choices and profitability in the future.

The day of the Ponzi is over folks.

Grow organically, manage your cash flow, and ask yourself this - if you lack collateral or capital, why should someone else loan it to you if you're not able to pay it back?

If you don't lack capital or collateral, why is it that you want someone else - in this case a bank - to take risk with THEIR capital you won't take with YOURS?

Consumer Credit: What Good News?

nospam@example.com (Karl Denninger) — Sat, 06 Feb 2010 10:59:33 -0500

Bloomberg said:

Feb. 5 (Bloomberg) -- U.S. stocks rose, rebounding from the biggest losses since March, as investors speculated the European Union may come up with a solution for budget deficits in Greece and Spain and consumer credit dropped less than forecast.

Bah.

Here's the shorter-term outstanding credit picture...

And the rate of change....

Yes, there was a small uptick in non-revolving debt taken on (cars?) but the credit card rate-of-change continued to blow and during the Christmas month it declined by a net $8.5 billion.

Let me also point out that last December, which allegedly was the "depths of Hell" when it came to consumer behavior, revolving credit declined by $6.6 billion.

This December revolving debt declined by 29% more than it did last Christmas season!

Now perhaps you can square that with the claims of a "good" Christmas season that had increased consumer sales, and perhaps you can claim that this somehow represents that the de-leveraging is coming to an end in the consumer space, but I cannot.

First, from a "big-picture" perspective, here's the consumer credit outstanding graph going back to the late 1960s:

The so-called "consumer revolution" happened through "increased earnings" eh? Uh, no. It happened due to increasing leverage, and this report, may I remind you, does not include mortgages - that's in the Z1, which comes out quarterly.

Here's reality folks: people are paying down their credit cards and keeping their car loans current by ignoring their mortgage notes!

The percentage of consumers delinquent on mortgages, but current on credit cards rose to 6.6 percent in the third quarter of 2009 from 6.3 percent in the previous quarter and 4.9 percent in the same quarter a year earlier, a new study developed by TransUnion showed.

The trend first emerged in the first quarter of 2008 when it was at 4.3 percent, Chicago-based TransUnion said.

So in reality we have people who are maintaining their spending by living free in their homes, producing this sort of credit report snippet, as I reported on yesterday:

That's more than a year of "120 days+ late" reported, sequentially, with no foreclosure to close the file.

We have here a mexican standoff. The American People have increasingly figured out that the banks are lying about their asset quality and in fact are lying about their profitability by marking their "assets" to myth - that is, ignoring bad loans. They are doing this by refusing to foreclose on defaulted mortgages, as that action would force them to recognize the loss.

Therefore, the logical thing for a consumer who is strapped for money to do is to erect their middle finger toward the bank that holds their mortgage, and instead pay their credit card and live on the money they would otherwise send in for the mortgage, thereby pumping their lifestyle beyond what they could otherwise afford. Some people are undoubtedly doing this even if they could pay the mortgage.

This is what happens when the government countenances, embraces and even promotes false accounting and bogus financial activities - the people figure out the game and come along for the ride as well.

This is "touted" by mainstream media and the government as "economic improvement" when it is no such thing. The underlying quality of the assets behind those loans continues to deteriorate as the payments are not being made. The deficiency continues to grow, eroding the capital base behind the book of alleged "assets." Eventually this rot of the foundation will cause the all-on catastrophic collapse of these banking "empires", and since we have refused to cage the credit-default swap monster and in fact empowered him by legalizing bogus "mark to model" accounting fictions the deficiency has been allowed to grow to the point that, if we allow this to continue much longer, not even governments are likely to be able to stop it when it begins to topple.

Do not be fooled by false Gods. The fact of the matter is that consumers have hit the wall. We continue to believe that consumer credit loads are "reasonably serviceable" yet the percentage of the civilian workforce that is employed is back to where it was before "women in the workforce" became a serious component of working America, and near the peak levels of the years prior to that time.

In summary we have solved nothing, credit outstanding deteriorated in the revolving space at a rate 29% faster than it did during the last Christmas season, and there is no good news to be found in the employment coverage ratio - the critical factor for the government being able to raise coverage for its debts via taxation.

PS: You think the big bad central bankers don't know this? If they truly believe everything is ok, China really doesn't have trillions of Yuan in bad debts in their banks that are being hidden, and we're not going to see lots of Portugese-style auction failures along with Greece, Spain, and eventually the UK and America follow it down the bowl, why is there a secret meeting of central bankers taking place in Australia this weekend?

More Examples: Massive BS Accounting

nospam@example.com (Karl Denninger) — Fri, 05 Feb 2010 11:05:00 -0500

I know I keep harping on this, but it's important.

I keep getting copies of various evidence that the banks are not properly handling defaulted mortgages. The instance I present here is a mortgage - a "conventional" loan - that has been reported as "120 days past due" to the credit bureaus for THIRTEEN CONSECUTIVE MONTHS.

What the hell sort of game is this?

Note that it was also reported 60 late twice too, but that's reasonably possible - it went late, went 60 late, the debtor made one attempt to pay it down but still was 60 late, then gave up.

This person has been living in their house without making a mortgage payment for nearly a year and a half, and the bank - it's one of the "Big Three" - HAS NOT FORECLOSED.

This crap has to stop folks. Yeah, this is an anecdote, but I have to ask whether the auditors have looked into this. A loan that has this "payment history" ought to be carried at recovery value, but that would mean it would be "marked to the market", and we know the banks all got permission to mark 'em to "model" back in the early part of 2009.

This sort of BS game is too damn prevalent. There is no reason other than cooking of the books that institutions would hold paper like this in a perpetual "not paying and not gonna pay either" state rather than foreclose and take the hit - except to present a view of their financial status that is less than completely honest.

"Extend and Pretend" may have been made legal but that doesn't make you solvent - it just means that the government made legal what formerly was called accounting fraud, and the inescapable reality is that eventually the cash flow will get you anyway.

To the banks: CUT IT OUT!

To the regulators: STEP ON SOME NECKS!

To Congress and "The Cops": STOP THE LOOTING AND START PROSECUTING!

Robert Reich Failed Home Economics

nospam@example.com (Karl Denninger) — Fri, 05 Feb 2010 10:11:00 -0500

Really.

You know that class that was required in "High School", and was largely responsible for it having its moniker - because you could literally be stoned through it and get a 100?

Well Reich failed, because he couldn't balance a checkbook.

Alright class, here's your assignment: Look at President Obama's budget proposal, spending freeze, jobs bill, stimulus, tax hikes on upper-income individuals, and proposed deficit commission. Also take a look at the fees he wants to impose on the biggest banks, and his proposed regulations of Wall Street. Look at his stalled trade agenda. Now, explain the big picture.

Ok, I'll take a shot:

$500 billion in newly-embedded STRUCTURAL deficits in concert with rapidly-falling tax revenues = ultimate insolvency of the US Treasury.

Oh wait, you didn't like that answer. Here's what Reich said:

If you're about to write "more taxes and more spending," you're either not thinking hard enough or you're a Republican running for office this November.

To see the big picture you need to keep your eye on three big things. The first is the extent of government spending needed to offset the continued reluctance of consumers and businesses to spend.

It's not reluctance. It's inability. That's usually what happens when your general mantra is "I can't be out of money - I still have checks left!" and then try the same trick with your credit card only to have it come back "REALLY DECLINED."

You don't have to be an orthodox Keynesian to understand that as long as the private sector is deleveraging the public sector has to borrow and spend in order to keep the economy moving forward.

I don't have to have an IQ larger than my shoe size to understand that when the private sector has reached it's leverage limit it is not possible to "spur" it to take on more leverage - that is, to borrow and spend that which isn't earned in the present tense.

All government borrowing and spending does in that case is make the ultimate deleveraging (across the entire economy) WORSE.

Of course those who pray at the Keynesian altar (or for that matter, virtually all the other altars when it comes to economics) don't have "D" (debt) anywhere in their economic calculations and pronouncements.

Their error is primary - they believe in "MV = PQ", but think "M" is the money supply. It's not - it's the credit supply, but for each dollar of credit there is one of debt, and when the ability to carry that debt reaches its limit you have hit the economic wall and "P", "Q" or both must CONTRACT.

Reich, I'll issue to you you the same challenge I issued to Krugman - want an hour-long debate with me on Internet radio? This coming Monday or any Monday - simply get ahold of me and I'll be happy to hash it out with you.

It's a hell of a lot harder to influence people when you have to defend your claims rather than just spout off on the opinion page - where nobody has the ability to force you to defend your preposterous claims.

Krugman Displays Liberal Idiocy

nospam@example.com (Karl Denninger) — Fri, 05 Feb 2010 09:45:18 -0500

Can someone revoke this jackass' degree?

Or perhaps I should award him an honorary degree in lying?

Just one paragraph please...

Let’s talk for a moment about budget reality. Contrary to what you often hear, the large deficit the federal government is running right now isn’t the result of runaway spending growth.

Really Paul?

How about some facts instead of lies?

Argue with The Fed if you'd like Paul, but unless you're prepared to have a discussion on the actual facts, shut the hell up.

PS: Your claim about interest costs being "manageable" relies on foreigners being willing to continue to lend the Federal Government money for a near-zero interest rate while at the same time our labor force is collapsing. Bonne chance mes amis.

PPS: Here's an open challenge to you - want to come on for an open debate with me on Internet Radio? Bring your best rapier - you'll need it.

Un(Employment) Friday 2/5

nospam@example.com (Karl Denninger) — Fri, 05 Feb 2010 09:16:00 -0500

The data continues with the January Employment Situation Report.

The top-line was a loss of 20,000 jobs but the unemployment rate "as reported" fell from 10.0 to 9.7%.

This was good for an almost-immediate 10 point ramp in the futures, exactly as I had talked about last night in the video - the potential for anything "in line" to provoke a snapback was quite real, and it became realized - at least until people actually read inside the report, that is!

But one must dig into the report and try to determine if we're seeing real improvement, or whether we've got statistical adjustments, remembering that January is a difficult month under the best of times because of benchmark and annual revisions.

And here we find some problems.

First, let's start with the good news:

While we're not gaining employment yet the direction of the move is back toward gains - and has been since September. The trajectory continues, but one must remember that until this number has a positive sign in front of it, we're still losing.

The problem is that a big part of this has to do with revisions to population "guesses" that were put into the system for this month. When one looks there, we see a few problems - first, the usual "January Effect" change in the "Not In Labor Force" table:

It is common to find downticks in this chart in January - but whether they mean anything is another matter. We had one last year, we had one the year before, and we had one this year. While the last few years this has been a negative print (improvement) there are years in which the change was positive. Whether this is a consequence of the population normalization that happens every January or whether it's real will have to wait for another month or two. One month a trend does not make.

But in some of the other details things don't look so good, where we look at the product of these statistical adjustments that filter through to both sides of the sheet.

That ain't good. The total employed continues to decline, which is in line with the actual report. So in this case household and establishment are in alignment - and showing continued losses. The bad news is that in the household survey the trajectory of losses has resumed since September its downward trend - and shows no evidence of improvement.

Then there's the ugly.

That's real bad. This looked to be stabilizing in the middle of 2009, but no more.

This latter chart, ultimately, is the one you can't ignore, and it's the one that will, if it continues, eventually strip the government of its ability to both borrow and spend on an unlimited basis. To the extent that you believe that the government is both able and willing to prop up the civilian economy with various "stimulus" games such ability is absolutely reliant on the trend in the above chart not continuing its deterioration.

I'll make a prediction based on the above - there are going to be some truly ugly revisions to IRS tax receipt assumptions. I don't know if the bond market will sit up and pay attention ala Portugal, but if it does the "little sell-off" we've seen thus far is a nothingburger compared to what's coming.

Who Remembers This.....

nospam@example.com (Karl Denninger) — Thu, 04 Feb 2010 14:28:00 -0500

Or if you prefer....

To those who think that "it's all going to be ok" let me point out a few things I've said repeatedly since this entire mess began and The Ticker began publication.

We're screwed - they're screwed worse. Greece anyone? Oops - it's not just Greece, it's also Spain and Portugal, and now we're seeing failed bond auctions. Ka-Boom!
China will save us. Oh really? Why is it that China's government is talking about bailing out their own banks? What could possibly go wrong with average home prices in parts of China exceeding 80x average incomes?
We fixed nothing with all the screwing around. All we did is let the clowns steal more money. There has been no cleaning out of the fraudulent securities. Some have been transferred to your tax account - that is, you will be forced to pay for them in the future. But even more remain out there. Fannie/Freddie anyone? FHA defaults? CDOs, RMBS and others that continue to come under pressure and suffer downgrades? Second mortgages (HELOCs and similar) that are functionally if not mathematically worthless? Who's taken account of all these and written them off? Nobody. "Extend and pretend" only works until the cash flow dries up. Then you're doubly-screwed because the value of what you hold has declined further.
The economy is not improving. No jobs, no economy. We shipped all our good jobs overseas in the quest for $30 DVD players. We got 'em - but we lost the ability to employ people in other than asset-stripping jobs for more than $50,000 a year. We refused to address the currency and import/export imbalances and still are, despite all the jawboning.
The book cooking continues. CISCO comes out with "great" earnings but hidden in there is the fact that they're writing their own financing - and holding it off-book. Banks are still carrying HELOCs behind underwater firsts at or near PAR, even when the first is non-performing. Those loans have a literal zero recovery value. What could possibly go wrong with hiding asset quality (or lack thereof) off balance sheet where nobody can see it? Nobody remembers Lucent? Enron? It wasn't THAT long ago. Will it get CISCO or these banks? I have no clue but this much I do know - nobody ever hides good news, they sing from the rafters. You judge what's going on here.
We did not neuter the CDS monster and it is now threatening to stomp on more churches. They're blowing out again - this time on sovereigns. Greece, Spain, Portugal. Don't worry, they'll be back on banks too, perhaps on Britain, and what's next? The US, probably. We had the opportunity to flat-out declare these things illegal gambling contracts and tear 'em up. Yeah, it would have led to massive lawsuits. And? These damn things are toxic, they're an inherently fraudulent scheme in that nobody is being forced to hold margin against their exposure (and thus they cannot be paid as agreed) and they're a big cause of the mess snowballing, since they provide huge leverage and that can burn you just as badly as it "helps." I've been warning for a good long time on this, but nobody wanted to listen. Now we're seeing Round #2 over in Europe. This is not over.
We have foolishly tried to prevent home prices from contracting and in doing so have fueled even more trouble. Now we've got people intentionally defaulting - following precisely the paths that banks are taking with places like the offices in California and the huge apartment complex in New York! If it's good enough for them, it damn sure is good enough for me! And why not? Are there consequences? Sure, in some cases you can get nailed with a deficiency judgment and your credit will be trashed in all cases. But the banks are partly responsible for this push-back as well - many of them have gone so far as to push on debtors to raid 401k or IRA accounts, which is outrageous - those assets are protected in a bankruptcy. That sort of pressure ought to be felonious (and prosecuted as extortion) - but of course it's not - if you're a debt collector.
We claim that auto sales are "strong" but in fact they're down huge from where they were through 2006. There's no "great" market there. We're doing what - 10.5 million units? That's a number last seen in the 1980s but we have how many more million people in the US today? Truth: Auto sales are off 40% or more from the last decade's numbers - not just the "hayday" of 2006.
We claim that the economy is "recovering" but consumers remain tapped out and continue to shed debt. Instead of addressing this and dealing with the fact that we built too much capacity into the economy (all predicated on "pulled forward demand") we instead are trying to reinflate a popped bubble and are peddling false hope. This in turn has led small businesspeople (especially) to make very bad decisions for which they will likely pay - instead of an orderly wind-up of their operations many have doubled down and will, in the next year or two, be financially destroyed. Responsibility for this false hope rests solidly on the shoulders of the ToutMedia and government "pumpers."
We have in fact pulled forward the disasters in Medicare and Social Security. The Massachusetts Senate election didn't cause the selloff in the market because suddenly "health care wasn't going to be reformed." However, the federal budget now has a smoking hole in it where the fraudulent so-called "reform" was formerly going to provide hundreds of billions of dollars in additional tax money that was going to be literally stolen under the pretense of "health care" for the people later that was NEVER going to be delivered. Social Security and Medicare are now both either in or close to going cash-flow negative. These programs have been used for 20 years to lie about federal budgetary holes and now that chicken has come home to roost. We don't have the money, we can't tax the money into existence and we can't pay. We must have an honest discussion with the people of this nation regarding entitlements - the two-thirds of the budget that is currently "untouchable" - but we still refuse to do so. I thought we had another 5-10 years before this bomb blew up in our face. I was wrong - it's here and now. This is going to be one of the most-difficult issues to face and solve - even more so than locking up all the fraudsters on Wall Street. But this is a can that cannot be kicked any more. (There's an extensive Ticker in the pipe on this very subject - watch for it.)

Might this selloff that we're into now be "a blip"? Maybe. But it doesn't change the trajectory, nor does it change the fact that we didn't get the sorts of valuations and metrics that come with durable Bear Market bottoms in early 2009. As such we are vulnerable to not only a dive back down to those levels but materially below them if we do not deal with the underlying problems, and to date, there is no indication that our government or industry will do so.

Keep playing the Pax Americana theme folks. Reality is coming and it's a clue-by-four aimed straight at your heads.

"A Good Start" - Cuomo Charges BAC

nospam@example.com (Karl Denninger) — Thu, 04 Feb 2010 12:27:00 -0500

Well well well... I SEE A COP!

The attorney general’s accusations, detailed in a 90-page complaint, focus on two decisions that bank executives made in December 2008, as Merrill Lynch suffered growing losses. The complaint was filed under the Martin Act, a New York state law that gives the attorney general broad latitude to pursue financial wrongdoing.

“Throughout this episode, the conduct of Bank of America, through its top management, wasmotivated by self-interest, greed, hubris, and a palpable sense that the normal rules of fair play did not apply to them,” Mr. Cuomo said. “Bank of America’s management thought of itself as too big to play by the rules and, just as disturbingly, too big to tell the truth.”

Well Mr. Cuomo, you could say that about all the big boyz in your district and state. How about all those "RMBS" and "CDOs" and "CDO^s" and other similar instruments that were comprised of residential mortgages with no disclosure that The FBI, HUD and private credit analysts had been warning for YEARS about rampant fraud in the underlying loans?

I applaud this as a first step but until and unless this is expanded to include all those securities created with bought-and-paid-for ratings - and zero disclosure of facts either known or "should have been known if you bothered to look" to investors this will remain only "a good start."

C'mon Mr. Cuomo, make us all proud and go after the root of The Bezzle.

Derivative Fraud? Where Are OUR Cops?

nospam@example.com (Karl Denninger) — Thu, 04 Feb 2010 09:26:00 -0500

Amazing, when you consider the implications....

Feb. 3 (Bloomberg) -- Italy’s financial police are seizing 73.3 million euros ($102 million) of assets from Bank of America Corp. and a unit of Dexia SA as part of a probe into an alleged derivatives fraud in the region of Apulia.

Police are investigating losses on derivatives linked to the sale of 870 million euros of bonds sold by the regional government in 2003 and 2004, according to an e-mail from the prosecutor’s office in Bari today. The banks misled the municipality, located in the heel of Italy, on the economic advantages of the transaction and concealed their fees, the prosecutor said.

Remember that we've had a few of these here, right? Jefferson County Alabama anyone? They're not alone either, as I've pointed out repeatedly.

Once is an accident - or a rogue employee. Twice is a curious event. A pattern of conduct is racketeering.

Which do we have here? I don't know, but the refusal of our "regulators" to take this issue seriously, and they have refused, while foreign regulators are seizing assets is rather telling.

Then there's the FSA over in Britain, who recently put their foot down: Either stop cheating on bonus and tax rules or lose your banking license.

I have long written about The Bezzle in the financial system and that we must get it out of the system if we are to have something approaching real, verifiable and sustainable economic growth.

So far we have seen no interest in that from the regulators in this country, probably because they're well-aware that this would mean revoking some banking licenses and putting a lot of very well-connected people out of "business."

Where does it end in this country folks? There's more than enough evidence that "a river (of corruption) runs through it" - "it", of course, being our economic and banking system. Look at the update this morning out of "Biggovernment" related to the story I discussed yesterday with the AIG "takeunder" by The NY Fed:

The FRBNY wanted more than just a standard debt deal; it wanted absolute control and ownership of AIG. But, it was illegal for the FRBNY to hold equity and the Treasury Dept. did not yet have the legislative authority, later granted under EESA, to do so. But this didn’t stop then-President Geithner or his general counsel Thomas Baxter. They crafted the AIG Trust to accomplish the same goal. But the Trust was transparently invalid and illegal for two fundamental reasons: One, the FED maintained absolute control over the Trust’s existence, its terms, and the Trustees through Section 1.03 of the Trust Agreement. This, as we explain in our Response papers attached, invalidates the trust; yet the government continues to speak about this as an “independent” Trust.

That's a raw allegation of unlawful conduct, coming from a bar-admitted attorney.

WHERE ARE THE DAMN COPS AND WHY AM I HEARING HANDCUFFS CLANK SHUT IN THE UK AND EUROPE GENERALLY, WHILE HERE ALL THE COPS ARE IN THE DONUT SHOP SWILLING THEIR COFFEE?

Do I have respect for Barofsky? Yes. He has been like a breath of fresh air looking into these matters since he was appointed, despite what appears to be intentional and strong interference from Treasury and others.

But Barofsky is not enough and a few show trials to appease the proletariat won't solve the problem. The issues are structural and must be fixed, not papered over nor will offering up a few sacrificial lambs resolve a thing. Indeed such appeasement simply adds more instability to an already dangerous situation.

We have 50 State Attorney Generals and we allegedly have a federal Attorney General as well. There are more than enough cops to investigate the edifices and artifices that have been put forward by the so-called "financial system" in the name of "innovation" that, I believe, have in fact been nothing more than sophisticated equity and wealth-stripping schemes.

The housing market implosion laid bare upon the table The Bezzle, since there was simply not enough "slop" left in the system to hide it any more. As the layers of the onion have been peeled back we have found more and more instances where "products" were not structured for any reasonable economic benefit of the person or entity that was supposedly "helped", but rather as a means of stripping off funds through concealment of material facts either intentionally or through impenetrable complexity. So-called "CDOs" and "CDO^2s" were sold with thousands of pages of documentation "behind" them - a literal impossibility to read and understand before the "investor" plopped down his or her money. When these blew up it became apparent that the so-called "credit quality" contained in these securities not only didn't exist in the present it never existed - yet those little letters "AAA" were relied upon as representing credit quality equivalent to that of the United States Federal Government.

It's all BS folks and that we do not currently have literal dozens of Grand Juries empaneled to investigate and hand up indictments against the "titans of financial industry" on downward is an outrage.

We will not see true economic progress or recovery until we rid the system of the parasitic vampires that are literally draining the blood from our economic system. While some degree of embezzlement and fraud is always present in an economy when you reach the point that so-called "lending" has turned into a Ponzi-style circus with everyone looking for a greater sucker to offload their latest piece of trash upon at a profit (for them) you've also reached the stage where that nation's economy becomes subject to outright collapse.

We stared into that abyss in 2008 and early 2009, but rather than learn from it, revoking the business and banking licenses of the worst offenders, breaking up the monolithic businesses that threatened to blow up the world unless their demands for (even more) money were met, banning the opaque products and jailing the principals we have instead coddled them and saddled our children and grandchildren with the costs of bailing out the (proper and appropriate) detonation of these bogus transactions.

We have fixed exactly nothing that led to the implosion. Instead we erected a wall around the burning building claiming that the building inside the wall is not really on fire and then piled up barrels of nitroglycerine around the outside! Unless we get off our duffs and address the actual underlying cause of the mess - the rampant and outrageous scams throughout corporate America we will have not just another collapse as we witnessed in 2008 but a worse one, and it will come sooner rather than later.

Choose America.

Oh No... You Heard It Here First (Lucent Gastric Reflux)

nospam@example.com (Karl Denninger) — Wed, 03 Feb 2010 18:14:00 -0500

Oh please tell me this is BS:

NEW YORK (TheStreet) -- When Cisco last took the stage in November, CEO John Chambers predicted an uplift in business. He didn't mention at the time that the company would offer to lend a hand in the form of zero-percent financing.

Taking a page from the automakers' playbook circa 2002, Cisco introduced three-year, interest-free financing for its small and mid-sized business customers last week. The cheap loans are sure to help juice sales to cash-strapped customers far and wide.

Uh, no. That's not the playbook of automakers circa 2002.

It is the playbook of Lucent circa 1997.

Need I remind anyone how that story ended?

Lucent "sold" a metric boatload of hardware on capital financing at essentially zero interest terms to Winstar Communications - the firm that bought my Internet company - along with many others.

Winstar (and others) ultimately defaulted, unable to make their business goals turn into actual long-term cash flow.

Lawsuits flew and ultimately Winstar folded, all but destroying Lucent in the process, as they were stuck with an unbelievable amount of financed hardware that was not only generating no cash flow but which had depreciated (as all computer and network equipment does) to an insane degree the moment it was put into service.

Lucent - one of the most-storied technological companies ever to exist in the United States, the spun-off parent of Bell Labs that had years ago invented the transistor and slung us into the digital age and which held a solid majority of all telephone switch business in the United States, was later essentially forced to merge with Alcatel to avoid bankruptcy.

This is Ponzi-style financing and John Chambers knows better, having survived the 2000 tech crash in no small part because he didn't do the same thing that Lucent did and thus didn't get hammered by the defaults when the bust came.

The market has paid exactly zero attention to this "contribution" to CISCO's sales, and it won't in the immediate future either. You can count on it. I'm willing to bet there will not be one mainstream analyst who will point this out tomorrow morning in a research report and slap a big fat SELL on CISCO as a consequence. I sure didn't hear anyone on the Fast Money CNBS show bring it up.

The market loves a good bit of Ponzi Finance and typically rewards those firms that engage in it for quite some time - sometimes for as long as a year or two.

But each and every loan made below market price for the credit extended is impaired at origination. It cannot be otherwise as there is no such thing as a real zero or negative cost of capital, even if only on time value. "Spurring demand" by holding the risk on a product you sell looks good when you consider that after a year or two you could "eat it" and lose "just your gross margin", until you consider that you spent that margin on salaries and operational needs for the business in the interim.

That we are seeing this sort of crap again in the technology space just ten short years after it blew up last time, taking down one of the titans in the telecommunications space, is proof positive that there is no real economic recovery, there is no solid fundamental demand, and that it is financial trickery and games that are leading to these "excellent results."

I can't tell you when the collapse engendered from this round of BS will come, but I can tell you with all but absolute certainty that it will, just as I said it would last time when I saw this same game being played in this very same industry.

"This time it's different" - right John?

I look forward to FedExing a copy of this article to you in a year or two, with a big fat "I told you so" scrawed across the front of it in black sharpie marker.