Taleb video: credit crunch not black swan, moral hazard now worse

From Bloomberg:

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Some great comments on the OMB (“lying on their forecasts”), Geithner (“who has a mortage on a house not far from mine… who didn’t understand risk and real estate prices”), Summers (“uses wrong mathematics in his papers” and has “systemic arrogance”), and Bernanke (“the one who crashed the plane”).

He has praise for David Cameron, whom he thinks understands how to solve the crisis.

Plenty of fodder for inflationists and bond bears here: Hard assets like metals and agricultural land would be a good way to protect value. Forget the stock market and most real estate.

Does anybody, such as professors, now understand the issues he raises? No. Don’t go to business school, but if you go, don’t take any business class that has equations in it: “it’s all bogus.”

I thought the bailout was supposed to save the Euro.

In government and mainstream media logic, the bailouts are supposed to be good for the euro. With EUR/USD pushing 1.27, it appears that somebody forgot to tell the market that implied guarantees for GIPSI nations to the tune of 100s of billions of new euros should strengthen the value of those in circulation.

Here’s a 10-year view of the spot market, revealing just how much downside there is in this cross. On the other hand, the euro is getting oversold on a short-term basis, with RSI approaching the conditions preceding the short but violent rally in late ’08. It could trend a little while longer, but don’t get caught short without your stops.

TD Ameritrade

Key 2007 email sums up the mortgage situation. It’s not from Goldman.

Forget the middlemen – the real criminals are those who betray their oaths of office.

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Via the Motley Fool, here is an email from someone inside John Paulson’s hedge fund:

It is true that the market is not pricing the subprime RMBS [residential mortgage-backed securities] wipeout scenario. In my opinion this situation is due to the fact that rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while ‘real money’ investors have neither the analytical tools nor the institutional framework to take action before the losses that one could anticipate based [on] the ‘news’ available everywhere are actually realized.

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This guy was on the right track. Incentives are everything when you’re looking for explanations. The only things this guy left out were the role of government and the fact that managers did have the tools (google, for one) to figure out that there was a housing bubble.
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Government provided low-interest credit through Fannie and Freddie, which passed off much of the risk here to the taxpayer through their implied (later realized) guarantee. There was also the tremendous moral hazard of “too-big-to-fail,” which was always just a cover story to justify whatever taxpayer theivery the banks wanted to undertake. FDIC is also another massive risk-transfer scheme that encourages reckless lending by both bankers and depositors.
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Also key is the fact that the incompetent rating agencies, Moody’s, S&P and Fitch, only got that way after the government made them a cartel and removed market forces from their industry. If all rating agencies were paid by investors (rather than issuers) and had to compete on the basis of their performance, like Egan Jones, they would actually do some analysis.
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Goldman is a scapegoat. In the final analysis, they may be untrustworthy (who didn’t know that anyway), but they are just middlemen, and they didn’t force anyone to buy their bonds. They didn’t create the demand for junk credit — interest rates and spreads were very low during the bubble years, and huge institutional buyers with very highly paid managers simply failed to do their job of understanding what they were buying. Without their demand for junk mortgages, there could be no giant bubble. In the case of public pension funds like Calpers, this demand was partly the result of unrealistic promises made to unions which required very high annualized rates of return.
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For anyone who had read any economic history, the situation was plain as day (houses were selling for record multiples of incomes and rent, prices were way above trendline, credit was ridiculously easy, and speculation was rampant). If I saw it as a 20-something kid using google, how could the big shots miss it? The reasons are similar those in any mania, with heavy doses of moral hazard, group-think and extreme optimism. It’s all clear in retrospect, but back then only the weirdos, historians and Austrians were removed enough from the zeitgeist to see it.
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If you want to single out firms and individuals for retribution, look at those who betrayed their oaths of public service during the bubble and the Heist of ’08: Tim Geithner, Hank Paulson, Ben Bernanke, Alan Greenspan, Chris Dodd, Barnie Frank, Nancy Pelosi, Chris Cox, etc. Forget the middlemen – these are the real criminals, the people who lie into cameras for a living and deploy force against the citizenry (as a taxpayer you are forced under threat of imprisonment to absorb the losses on bad mortgages you neither bought nor created).
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The bankers can buy this power, but only because it’s for sale. Bankers don’t even have to violate the law to lock savers into their paper money cartel and pass off risks to the taxpayer — their lackeys have fixed it all for them.

James Grant: Put bankers’ own assets on the line again.

The market is the best regulator. After almost 100 years, it’s time we brought it back.

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Jim Grant has been the living best banking historian since 1995 when Murray Rothbard kicked the bucket. Last week in WaPo, he put forth is old-time solution to banking reform: make bank executives and even shareholders personally liabile for depositors’ losses.

The trouble with Wall Street isn’t that too many bankers get rich in the booms. The trouble, rather, is that too few get poor — really, suitably poor — in the busts. To the titans of finance go the upside. To we, the people, nowadays, goes the downside. How much better it would be if the bankers took the losses just as they do the profits.

Of course, there are only so many mansions, Bugattis and Matisses to go around. And many, many such treasures would be needed to make the taxpayers whole for the serial failures of 2007-09. Then again, under my proposed reform not more than a few high-end sheriff’s auctions would probably ever take place. The plausible threat of personal bankruptcy would suffice to focus the minds of American financiers on safety and soundness as they have not been focused for years.

“The fear of God,” replied George Gilbert Williams, president of the Chemical Bank of New York around the turn of the 20th century, when asked the secret of his success. “Old Bullion,” they called Chemical for its ability to pay out gold to its depositors even at the height of a financial panic. Safety was Chemical’s stock in trade. Nowadays, safety is nobody’s franchise except Washington’s. Gradually and by degree, starting in the 1930s — and then, in a great rush, in 2008 — the government has nationalized it.
No surprise, then, the perversity of Wall Street’s incentives. For rolling the dice, the payoff is potentially immense. For failure, the personal cost — while regrettable — is manageable. Senior executives at Lehman Brothers, Citi, AIG and Merrill Lynch, among other stricken institutions, did indeed lose their savings. What they did not necessarily lose is the rest of their net worth. In Brazil — which learned a thing or two about frenzied finance during its many bouts with hyperinflation — bank directors, senior bank officers and controlling bank stockholders know that they are personally responsible for the solvency of the institution with which they are associated. Let it fail, and their net worths are frozen for the duration of often-lengthy court proceedings. If worse comes to worse, the responsible and accountable parties can lose their all.
The substitution of collective responsibility for individual responsibility is the fatal story line of modern American finance. Bank shareholders used to bear the cost of failure, even as they enjoyed the fruits of success. If the bank in which shareholders invested went broke, a court-appointed receiver dunned them for money with which to compensate the depositors, among other creditors. This system was in place for 75 years, until the Federal Deposit Insurance Corp. pushed it aside in the early 1930s. One can imagine just how welcome was a receiver’s demand for a check from a shareholder who by then ardently wished that he or she had never heard of the bank in which it was his or her misfortune to invest.

Nevertheless, conclude a pair of academics who gave the “double liability system” serious study (Jonathan R. Macey, now of Yale Law School and its School of Management, and Geoffrey P. Miller, now of the New York University School of Law), the system worked reasonably well. “The sums recovered from shareholders under the double-liability system,” they wrote in a 1992 Wake Forest Law Review essay, “significantly benefited depositors and other bank creditors, and undoubtedly did much to enhance public confidence in the banking system despite the fact that almost all bank deposits were uninsured.”

Like one of those notorious exploding collateralized debt obligations, the American financial system is built as if to break down. The combination of socialized risk and privatized profit all but guarantees it. And when the inevitable happens? Congress and the regulators dream up yet more ways to try to outsmart the people who have made it their business in life not to be outsmarted…

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For the record, I agree 100% with Grant’s solution. Moral hazard is THE cause of the de-facto bankruptcy of nearly every major bank in the US.
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The US banking system pre-1913 was not perfect (unscrupulous bankers were always trying to use the power of the government’s guns to game the system), but it was much safer and more honest than today’s.
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Bankers did not yet have a license to blow bubbles, since there were no black checks from their creation, the Federal Reserve, which can simply print paper money to bail them out in the inevitable busts. Before the Fed, their own assets were on the line, and before FDIC, the depositors’ assets were at risk. These two parties had a very strong incentive to keep lending standards prudent.
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There were booms and busts, but they were localized, and at no time did the entire banking system become insolvent like it has been since 2008. Weak banks lost their depositors to those who had been prudent, and depositors knew that they were taking a risk when they chose a bank paying higher interest.
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In sum, the market is the best regulator. It’s time we brought it back.
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The benefits of unemployment insurance

From nymag.com comes this diary of a female 24-year-old New Yorker making the best of her 18 months of unemployment insurance:

DAY ONE
Noon: Finally wake up and realize that it’s only noon. Automatically type into SeamlessWeb to order the usual brunch. It’s just too rainy to leave the apartment. Since getting laid off (okay it’s been six months now), life has been a cycle of drinking, boys, hangover, and Seamless.
4 p.m.: Attempts to go the gym prove futile as hangover from last night manifests itself in every way. Make plans for the night and convince another ex-banker to hit the bottle with me. Everyone used to work hard, play hard, but the ones still employed are too afraid of getting sacked to have late nights.

8 p.m.: Friend comes over to pregame with my bottles from Trader Joe’s (hey, I’m laid off), and we thank God for unemployment insurance because it pays us to live in our expensive luxury apartments with no income.
Midnight: We head to Greenhouse and there is a line down the block, but I know the door guy; coincidentally, he is also the manager of the café next to the investment bank I used to work for. Only in NYC. He promptly lets us in and gets us the first round.
4 a.m.: The night becomes fuzzy and I black out once again. You would think by 24 I would know the fine line between sober and blackout, but I haven’t figured that out yet.

Read on for days 2-7 of this tale of “approximately zero acts of intercourse (hard to tell); two dates to cover dinner costs, one with old man and one with vegetarian; approximately six hookups with six men; one aborted threesome.”

Yet another way in which government “safety nets” create moral hazard.

The attitude expressed here towards money and sex is fairly representative of this demographic (recent big name college grad investment bank / law firm employee living in Manhattan). I just wanted everyone to have a little more insight into where their tax money is going. Without your help the big banks would all be gone and their employees would be well on their way to becoming humble and productive members of society, like cab drivers.

That great economist, Ben S. Bernanke

For your amusement, here’s Bernanke a couple of years ago doing his best to downplay our problems:

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To the dismay of many a fair-minded observer, Bernanke the Fool has been nominated for another term as Fed chairman. My comment is, so long as there is a Fed, who cares who runs it? The chairman, like the US President, is nothing but a figurehead. He provides lip service for policies that exclusively benefit the cartel of big banks.  Thus it has been since the Morgan, Schiff, Warburg and Rockefeller syndicates conspired in 1913 to draft the Federal Reserve Act and ram it through Congress two days before Christmas.

I’m a little bit surprised that Bernanke was nominated again, since there is such low public opinion towards him and his employer. I thought that he might be thrown to the dogs to satisfy the public’s urge for ‘change,’ but I guess the logic is that by keeping him on they can better preserve the fiction that the Fed saved the world. He is also very lucky that the nomination schedule coincided with the likely peak in Wave 2 sentiment (2nd waves are characterized by the near consensus that the old trend is back to stay, in this case, the Great American Bull Market).

Along the same line, I’m also surprised that the campaign to audit the Fed hasn’t found more support from the White House, since it would be the perfect PR opportunity for them to pretend that they were independent of the bankers. I half expect to see the audit happen, with the results decided in advance of course, something akin to past Congressional “investigations.” Maybe they will have to do something like this once mood sours again with the next wave of foreclosures, bank failures and panic selling in the markets.

The real campaign should be to end the Fed, not audit it. We already know what it does, and they are actually surprisingly transparent for such a sinister institution. It’s all right there on their website.

In praise of bank runs, the only regulator we need

Graphite here. Mike has asked me to join up as a guest blogger, and since I’ve always loved the spirited mix of finance, politics, and righteous anger of The Sovereign Speculator, I’m happy to come aboard.

If you needed another sign that this deflationary crash is just getting started, take a look at this blog post over at The Baseline Scenario. It’s stunning that in August 2009, with the FDIC in a state of de facto bankruptcy, anyone can write “the FDIC works” with a straight face. Just because it’s not the kind of horrible fascist “solution” that the current pack of knaves in Washington would pursue, doesn’t mean it’s some kind of brilliant idea.

The FDIC’s explicit purpose is to bail out imprudent depositors at the expense of prudent ones. If it wasn’t for the FDIC, all those people strutting into Corus’s Chicago branches to put their money in CDs yielding 0.25% more than the competition might have been just a little bit more concerned that it was going to fund condo development projects in Florida. Instead, they got a free lunch — why look at where your money’s going when Uncle Sucker (sorry, Sam) gets to eat the losses?

The idea that the FDIC “self funds” out of the banking system is nothing but a polite fiction. It has nearly always had to rely on taxpayer bailouts when resolving banking crises. Meanwhile, the banks that stayed prudent, made reasonable loans, and kept their reserve deposits in more liquid holdings are being slammed with huge assessments and fees, which are preventing them from recapitalizing themselves or offering better rates to their customers — in effect, spreading the stress and weakness of America’s worst banks to its best ones.

Yeah, this is a great solution to the problem of bank runs. Let’s see what happens when we really do get a full banking panic and the FDIC needs to go draw on its $500 billion line of credit with the Treasury. If you think that story ends with American depositors happily riding off into the sunset with their cash, I’d love to have some of whatever you’re smoking.

People talk about bank runs as though they’re some kind of unmitigated evil, just because some people lose money. As a matter of fact, they impose discipline and order on both banks and depositors, and ensure that the banking system as a whole remains diverse and resilient to major shocks. The moral hazard created by the FDIC was one of the most important drivers of the concentration of deposits at a few mega-banks, which (all carping about the “unregulated shadow banking system” notwithstanding) were the primary source of the awful lending binge which precipitated the credit crisis.

Look for a bottom after people finally start to dismiss, ignore, and ridicule the FDIC and its absurd apologists.

Ron Paul sums up the crisis in 3 minutes

(thanks again to zerohedge for finding this video)

I remember when I first discovered a speech by Ron Paul back in boom-time 2005, and was shocked that a Congressman was so eloquently warning of the dangers of fractional reserve lending, the Federal Reserve system, and welfare/warfare deficit spending. It was the first time that I could fully respect a standing politician.

Dr. Paul is still the nation’s strongest voice for an honest monetary and banking system, and he delivered a zinger in front of Bernanke and Frank yesterday. If, like me, you haven’t heard him speak in a while, have a listen and you’ll remember why his campaign was so exciting for so many of us.

Money quote: “I would suggest that the problems we have faced so far are nothing compared to what it will be like when the world not only rejects our debt, but our dollar as well. That’s when we’ll witness political turmoil that will be to no one’s benefit.”

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Now wouldn’t it be great to have Peter Schiff to cause the same trouble in the Senate?

Greenspan was Framed! Blame bankers’ moral hazard, not their lackey.

Source: The Johnsville News

Source: The Johnsville News

The Cover Story

It has become commonplace to lay blame for the greatest of asset bubbles on the inflationary policies of Sir Allen Greenspan and his employer. A typical critique goes something like this: For the last 20 years, every time the market started to liquidate bad debts and malinvestments (the junk bond bust, the crash of ’87, the early ’90s recession, the LTCM blowup, and dot-com crash), Greenspan just turned on the money spigot and made it all better again with lower rates. Because he so encouraged borrowers and lowered or eliminated reserve limits for lenders, we avoided the necessary catharsis and let bad investment pile upon bad investment, with ever increasing asset prices and debt levels, until we reached the stratosphere last year. By then the system had become so saturated with debt, and asset prices so high, that mass bankruptcy and liquidation was inevitable.

The Real Killers

This history is correct, but not complete, and it lays no blame on the true evil at the heart of the age-old problem of the credit cycle. In any analysis of historical events, one must sift through dunes of BS, and the best way to do that is to ask, Qui Bono? (“as a benefit to whom?”). The answer of course, is bankers and their perennial sidekicks, politicians. The latter designation includes the ‘Maestro,’ whom, while valuable for his mastery of obfuscation, could have easily been replaced had he not played ball. Bankers have no qualms about overextending credit, because they, more than any other party, control the government. Politicians and the bureaucracies they create have always worked for money, and bankers have always been the highest bidders.

The Means

The primary mechanism by which bankers steal from the public is fractional reserve lending, which is enabled by the socialization of losses through FDIC insurance and the Federal Reserve’s monopoly over currency.  FDIC absolves commercial bankers from responsibility for their client’s deposits, and the Fed and Treasury lock the public into the rigged system.

The Motive

Within FDIC limits, depositors have no incentive to seek out banks that employ sound lending standards. Because banks are all equally safe from the depositor’s point of view, bankers have no incentive to be cautious. They have a strong disincentive to be so, because the more credit banks extend (the higher their leverage), and the shakier the enterprises to which they lend (at higher interest), the higher their rate of return during the credit expansion (inflation) phase of the cycle. The name of the game is to grow your balance sheet as fast as possible, with little concern as to reserve ratios or collateralization.

The Opportunity

Once the bust arrives, bank executives have already collected so much in salary and bonuses and sold so much stock to an ever-credulous public, that it isn’t very painful for them if their bank fails, since they have become rich. But once a bank gets big enough (remember, the name of the game is to expand your balance sheet), it is easy for its now powerful executives to ‘convince’ politicians that failure would be so damaging that the Treasury (i.e., public) must assume its debts for the greater good.  At critical times, it may be desirable to cut out the middle man and place a trusted member of the cartel directly in the federal executive.

The Fed is Just an Accomplice

In the meantime, the Federal Reserve is called upon to extend cheap credit to banks in general, which often entails the printing of new paper or digital money. The lower base rates that ensue help banks to get off their feet again by encouraging the public to borrow more than is warranted by economic conditions. (Note: The above is how things worked before we reached Peak Credit last year, and the bankers and Fed are trying with all their might to inflate again, but they will be continually confounded. The game is now over, because nobody wants or can afford any more debt, and banks are finally so impaired by defaults that they cannot lend. Also, at $50 trillion in total private debt, the entire mess is now too big to bail, given the Fed’s mere $900 billion balance sheet.)

A Long History of Offense

So that is it in a nutshell: a completely corrupt monetary system. It is nothing new. We have had episodes like this since before Andrew Jackson abolished the first national bank. So long as a national bank has a monopoly on money creation and legal tender laws obligate the public to use fiat currency and not an alternative such as gold, bankers will retain a lock on the economy and the boom-bust cycle will continue, at great expense to our security and quality of life.

Can They Help it? Isn’t it Just Human Nature?

The credit cycle is a natural phenomenon, yes, but so is war. And just as right-thinking people oppose that other means by which the public is exploited by the oligarchy, so they should oppose fractional reserve lending and the institutions that support it: the Federal Reserve system, the FDIC, and legal tender laws.

Will Bill Gross please shut up?

“if we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury…” Bill Gross, September Investment Outlook

This guy continues to disgust me. If Americans before him had held the notions about markets that he does, there would be no wealth for him to manage, and he would not be a billionaire. This would be Venezuela.

Here is an excerpt from his latest bailout plea:

This rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time. Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami. Central bankers, of course, adopting the cloak and demeanor of firefighters or perhaps lifeguards, have been hard at work over the past 12 months to contain the damage. And the private market, in its attempt to anticipate a bear market bottom and snap up “bargains,” has been constructive as well. Over $400 billion in bank- and finance-related capital has been raised during the past year, a decent amount of it, by the way, having been bought by yours truly and my associates at PIMCO. Too bad for us and for everyone else who bought too soon. There are few of these deals now priced at par or above, which is bondspeak for “they are all underwater.” We, as well as our SWF and central bank counterparts, are reluctant to make additional commitments.

Step 2 on our delevering blackboard therefore has stalled and is inevitably morphing towards Step 3. Assets are still being liquidated but there is an increasing reluctance on the part of the private market to risk any more of its own capital. Liquidity is drying up; risk appetites are anorexic; asset prices, despite a temporarily resurgent stock market, are mainly going down; now even oil and commodity prices are drowning. There may be a Jim Cramer bull market somewhere, but it’s primarily a mirage unless and until we get the entrance of new balance sheets, and a new source of liquidity willing to support asset prices. …

A Depression-era bank robber named Willie Sutton once said that the reason he robbed banks was because “that’s where the money is.” Illegal for sure, but close to an 800 SAT score for logic if you were in the business of stealing other people’s money. And now, while some will compare current government bailouts to Slick Willie, citing moral hazard, near criminal regulatory neglect, and further bailouts for Wall Street and the rich, common sense can lead to no other conclusion: if we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury – not only to Freddie and Fannie but to Mom and Pop on Main Street U.S.A., via subsidized home loans issued by the FHA and other government institutions. A 21st century housing-related version of the RTC such as advocated by Larry Summers amongst others could be another example of the government wallet or balance sheet that is required during rare periods when the private sector is unable or unwilling to step forward.

The bill for our collective speculative profligacy, obvious in the deflating asset markets, can be paid now or it can be paid later. Those aspiring for a perfect 800 on the Wall Street policy exam would conclude that the tab will be less if paid up front, than if swept under a rug of moral umbrage intent on seeking retribution for any and all of those responsible. Now that the Fed has spent 12 months proving that it “knows something…knows something,” it is time for the Treasury to do likewise.

Sorry, Bill, I’m not scared. Systemic debt liquidation is exactly what the country needs right now, and actions like this are exactly what laid the groundwork for this bubble, by absolving bankers and guys like you from responsibility for your actions. To repeat these mistakes on such a massive scale would distort our economy into a perverse and Orwellian system for the sole benefit of politically connected billionaires.

Is Gross really that cynical?

If he’s not cynical, he’s dumb, and I doubt any self-made billionaire investor could be this dense. As Carl Denninger points out, Gross bought much of this mortgage debt over the last 12 months, at a big discount, surely with the full intention of lobbying for a bailout of his positions (he has been using his column, media appearances, and certainly contacts in Washington to do just that). A man with this kind of character could only be rewarded with wealth and prestige in a society that has gone completely off the deep end. Time to drain and scrub the pool.