We’ve been “Bankalized” Banks rule and always will

Ilargi Nov 8, 2010 I read an article Ashvin Pandurangi, our by now greatly valued roving reporter, sent me, entitled “Plutocracy Now”. Ashvin writes about that first notion I was pondering: the nationalization of US banks, though for him it’s not about Bank of America, but the Fed. He concludes it can’t be done, not even an audit will be achieved. And I think that goes for Wall Street banks as well. We can’t nationalize the banks, because they have long since “bankalized the nation”.

Not that I don’t find the efforts and arguments interesting. I just don’t think the authors necessarily place sufficient emphasis on the amount and level of political clout and power the financial industry has accumulated over the past few decades. Or indeed the past 100 years for that matter. Seeing them celebrate the birth of the Fed, and do so on Jekyll Island to boot, it makes me think the US is surely as far gone as Ireland is; it’s just that fewer people seem to realize it, but that’s not too comforting, is it?

Ashvin Pandurangi closes with a very insightful statement, one that every American should take to heart, and many Europeans too:

The reality is that there is only one way back to a true democratic system now, and this path will require nothing less of us than the courage of our forefathers.

The nation has been bankalized, something we’ve only figured out after it was too late. That means the road to taking over the banks is closed; we’ll be pumping money into them for quite a while to come.


Oct 30, 2010
A Paralyzed Fed Defers Decision On Monetary Policy To Primary Dealers In An Act That Can Only Be Classified As Treason
by Tyler Durden – Zero Hedge

Below are the 18 banks that, in a completely separate vote, will henceforth rule America, regardless of what particular puppets end up in the Congress and Senate:

BNP Paribas Securities Corp.
Banc of America Securities LLC
Barclays Capital Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Credit Suisse Securities (USA) LLC
Daiwa Capital Markets America Inc.
Deutsche Bank Securities Inc.
Goldman, Sachs & Co.
HSBC Securities (USA) Inc.
Jefferies & Company, Inc.
J.P. Morgan Securities LLC
Mizuho Securities USA Inc.
Morgan Stanley & Co. Incorporated
Nomura Securities International, Inc.
RBC Capital Markets Corporation
RBS Securities Inc.
UBS Securities LLC.

As if there was any doubt before which way the arrow of control, and particularly causality, points in America’s financial system, the following stunner just released from Bloomberg confirms it once and for all. According to Rebecca Christie and Craig Torres, the New York Fed has issued a survey to Primary Dealers, which asks for suggestions on the size of QE2 as well as the time over which it would be completed.

It also asks firms how often they anticipate the Fed will re-evaluate the program, and to estimate its ultimate size. This is nothing short of a stunning indication of three things:

* That the Fed is most likely completely paralyzed due to the escalating confrontation between the Hawks and the Doves, and that not even Bernanke believes has has sufficient clout to prevent what Time magazine has dubbed a potential opening salvo into a chain of events that could lead to civil war: in effect Bernanke will use the PD’s decision as a trump card to the Hawks and say the market will plunge unless at least this much money is printed,

* That the Fed is effectively asking the Primary Dealers to act as underwriters on whatever announcement the Fed will come up with, and thus prop the market, and, most importantly,

* That the PDs will most likely demand the highest possible amount, using Goldman’s $2-4 trillion as a benchmark, and not only frontrun the ultimate issuance knowing full well what the syndicate of 18 will decide in advance of what the final amount will be, but will also ramp stocks on November 3 to make the actual QE announcement seem like a surprise.

This also means that the Primary Dealers of America, which include among them such hedge funds as Goldman Sachs, such mortgage frauds as Bank of America, such insolvent foreign banks as Deutsche, RBS, UBS and RBS, and such middle-market excuses for banks as Jefferies, are now in control of US monetary, and as we explain below fiscal, policy.

It also means that the Fed has absolutely no confidence in its actions, and, more importantly, no confidence in how its actions will be perceived by the market which is why it is not only telegraphing its decision to the bankers, but is having its decision be dictated by them, an act so unconstitutional it would be seen as treason in any non-Banana republic!

This is the last straw confirming that the only ones left trading the market are the Fed and the PDs, passing hot potatoes to each other, and the HFTs, churning the shit out of everything else to pretend someone is still trading.

And the saddest conclusion is that this is the definitive end of US capital markets: not only is the Fed’s political subordination a moot point, but the Fed, and the middle class’ purchasing power via the imminent dollar destruction that is sure to follow as the PDs seek to obliterate their underwater assets by raging inflation, is now effectively confirmed to be a bitch of Lloyd Blankfein and his posse.

The official explanation for this unprecedented incursion by the banking crime syndicate in US monetary policy is as follows:

Avoiding Disruption

Treasury officials say they want to avoid any disruption to the $8.5 trillion market in U.S. government debt, the world’s most liquid, as the Fed weighs restarting large-scale asset purchases. The Treasury also doesn’t want to give any impression to investors, particularly those based overseas, that it might be coordinating with the Fed to finance the national debt.

“Treasury debt-management decisions are designed to deliver the lowest cost of borrowing over time and are entirely independent from monetary-policy decisions made by the Federal Reserve,” Mary Miller, assistant secretary for financial markets, said in an e-mail to Bloomberg News yesterday. Before joining the Treasury last year, Miller was head of global fixed- income portfolio management at T. Rowe Price Group Inc. in Baltimore.

The Treasury is scheduled to hold its quarterly meetings with bond dealers tomorrow, ahead of the department’s Nov. 3 refunding announcement.

Fill in the blank: the Fed has essentially given PDs the option of $250BN, $500BN or $1 trillion in monetization over six months. It is now absolutely clear that the PDs will pick the biggest number possible… which incidentally amounts to $2 trillion per year, and is precisely what Goldman’s downside case was, as we presented previously.

The New York Fed surveyed primary dealers required to bid in U.S. debt auctions. It asked dealers to estimate changes in nominal and real 10-year Treasury yields “if the purchases were announced and completed over a six-month period.” The amounts dealers can choose from are zero, $250 billion, $500 billion and $1 trillion.

Of course, since a $2 trillion purchase over 1 year means the Fed will have to monetize every single bond issued, the SOMA limit will have to be raised, another prediction we made months ago:

The Fed is unlikely to buy up the entire supply of new securities, although it may adjust its internal guidelines of how much it can hold of any given issue. The Fed limits itself to owning no more than 35 percent of any specific security it holds in its System Open Market Account, or SOMA.

“Our Treasury strategists point out it could also cause pricing distortions along the curve, if, for example, the Fed continues to target a 40 percent purchase concentration in the 6-10 year maturity bucket, as it has in its recent purchases,” analysts at JPMorgan Chase & Co., including Alex Roever, wrote in an Oct. 22 research report. The report predicts the Fed will buy about $250 billion a quarter during the easing campaign.

How about $500 billion?

And, incidentally, since the “independent” Treasury will be forced to issue more debt to fill all the demand for $2 trillion over the next 12 months, as there is not enough debt in the pipeline to fill $2TN worth of demand and prevent the entire curve pancaking at zero (i.e., the 30 year yielding precisely 0.001%) it also means that the government will be forced to come up with more deficit programs, which also means that primary dealers will now also determine US fiscal policy.

Which begs the question, why is anyone pretending that the political vote on November 3 matters at all?

Posted in Banking | Leave a comment

Jeff Rubin: Oil and the End of Globalization

Jeff Rubin: Oil and the End of Globalization

Nov 8, 2010. ASPO-USA

Much of the article has been snipped below:

It is easy to see how sub-prime mortgages blew up Wall Street; it is a little more challenging to see it as the author of the global recession.

  • Why were there economies that had no sub-prime mortgages that experienced even deeper recessions than the United States?
  • Why did those economies go into recession even before the US economy went into recession?
  • Maybe, just maybe, there was something more important going on–more important to the global economy than Wall Street or sub-prime mortgages, like $147 barrel oil, for example.
  • If we know anything about watching the global economy in the last 40 years, we know this: feed it cheap oil, and it runs very smoothly. All of a sudden, give it expensive oil, and it stops in its tracks.

Every major recession in the post-war period has oil’s fingerprints all over it.

  • The 1973 first oil shock led to what was then the deepest post-war recession, at the time. The second OPEC oil shock led to no less than two recessions: 1979 and 1982.
  • And then when Saddam Hussein invaded Kuwait, and left half of its oil fields on fire, and oil spiked to the then unheard-of price of $40 barrel, lo and behold, the industrialized world again fell into recession.

Oil prices went from about $30 barrel, at the beginning of 2004, to almost $150 barrel by 2008. Even inflation-adjusted, that price increase was over double the price increase of either the first or the second OPEC oil shock. If they had led to devastating recessions, why would not the biggest oil shock of them all, be the obvious culprit for what has been the deepest recession to date?

There are many ways in which oil shocks create global recessions.

  • First, the transfer of income. When oil went from $30 barrel, to about $147 barrel, over $1 trillion of income was transferred from the industrialized oil consuming world to OPEC. Now, that was not neutral for the economy, because the savings rates from which money was coming from, like the United States, was virtually 0%, meaning that consumers spent everything they made. And where the money was going to, places like Saudi Arabia, or Kuwait, or the United Arab Emirates, had savings rates of almost as high as 50%, so it certainly was not demand neutral.
  • High price also create recessions by crowding out non-energy expenditures. Two years ago, when gasoline cost us $4 gallon, low-income Americans were paying more to fill their tanks than they were to fill their stomachs.
  • But by far, the most important mechanism, the most important path, by which oil prices cause recession is through their impact on inflation, and their impact on interest rates.

There is no shortage of people to blame for the subprime mortgage crisis. The real culprit behind subprime mortgages was the very low cost of capital and 0% interest rates. All the greed in the world could not do what the Fed’s easy money made possible. The subprime mortgage rates were created by interest rates and the subprime mortgage market was pricked by interest rates. Everybody would agree with that. What people don’t seem to ask is, “Why did interest rates go from 1% to 5.5% from 2004 to 2006?”

Any central banker will acknowledge that your borrowing cost is a mirror image of your inflation rate. We had 1% federal funds’ rate in 2004, because we had a 1% inflation rate. All of a sudden, in 2006, inflation was over 5.5%, the highest it had been in America, since, coincidentally, 1991, when we just happened to have the last oil shock. All of a sudden, money wasn’t free any more. All of a sudden, you weren’t getting credit cards in the mail any more that you never applied for. And all of the sudden, people who held negative amortization sub-prime mortgage rates had to start paying 7% or 8%.

If interest rates hadn’t risen, that wouldn’t have occurred. Why did inflation move up? Virtually all of the increase in inflation came from one component of the US consumer price index basket–the energy component. By the end of 2006, energy inflation was running at 35%, because of one price: the price of oil. The price of oil went from $30 barrel, which incidentally, every oil analyst at the time said it was going to stay at that level, to over $70 barrel. If oil had stayed at $30 barrel, inflation would never have spiked; neither would have interest rates. All of those good folk in Cleveland would probably still be there, in their homes financed by 0% interest rate sub-prime mortgages. Lehman Brothers and Bear Stearns would probably still exist, and I’d probably still be the chief economist at CIBC.

But that is not what happened. Why did oil prices go up to $147 barrel? Somewhere where virtually every economist said it could not go. Well, there were two reasons that economists said that oil prices could not get into triple digit range, and that was the cherished principles of supply and demand. First, the theory of the upward sloping supply curve–higher oil prices would bring new supply, just like it did after the OPEC oil shocks, where oil gushed from Prudhoe Bay and the North Sea. And not only did that break OPEC’s strangle-hold on the market, but sent oil prices tumbling down.

But there are no more Prudhoe Bays or North Seas to tap. Tar sands and deep water oil did bring new sources of supply, but only at prices we couldn’t afford to burn.

What about the cherished principle of demand? Would not triple digit oil prices quash demand? Well, it did, in certain places. It did in the United States, Canada, Japan, and Western Europe. Fifteen years ago, if those economies suddenly cut back their appetite for oil, oil prices would have fallen, because 15 years ago, those countries would have accounted for almost 75% of world oil consumption. Today, they account for 50%. Tomorrow, they will account for less than half.

Where do you think oil demand has been growing the strongest? Many of you will probably be saying China, and indeed it has. It’s grown from around 2 million barrels a day, to about 9 million barrels a day. But I know a place where the demand for oil is growing even faster than in China. And it is the same place your politicians have told you your supply is coming from in the future. Last year, OPEC and two non-cartel producers, Mexico and Russia, consumed 14 million barrels a day. That is almost two Chinas.

What makes OPEC so thirsty for its own fuel? In Venezuela oil is 20 cents a gallon, 40 cents in Saudia Arabia.  And it’s 40 cents a gallon, whether oil costs $20 barrel, or whether oil costs $150 barrel. What’s the coolest thing to do in Dubai? Ski, of course. Skiing in an area where it’s hot enough to fry an egg on the pavement uses up a whole lot of energy. So the question isn’t really how much productive capacity that OPEC has. How much export capacity is the real question, and every year it’s less and less, because every year, more and more is consumed at home. So chances are, your future oil supply ain’t coming from OPEC, and chances are, it ain’t going to be cheap.

Now sure, oil prices fell to $40 barrel during the recession. And for many folk, that was evidence enough that it never had any business being in triple digit range in the first place. But what a lot of those folk forget is that in the last recession, world oil demand actually fell. It fell for the first time since 1983. Such was the severity that the recession was.

Peak oil is not a problem if the economy that it is powering is shrinking. Peak oil is only a problem if the economy we are in is starting to grow. The first thing you know about an economic recovery is that economies start burning more oil. The next thing you know about an economic recovery is that oil prices start rising. Where is oil trading today? It is trading at over $80 barrel. With the exception of Germany and Canada, every other economy in the G7 is still miles below the level of GDP that they were at before the recession began.

And yet, where oil is trading today, turn the clock back to three years ago, and that would have been a world all-time record high. Now, it is where oil trades in the shadow of the deepest global post-war recession. Where do you think oil prices are going?

I will tell you where I think oil prices are going. Even in this most anemic of economic recoveries, we are going to see triple digit oil prices.

Our rendezvous with triple digit oil prices is not in 10 or 15 years; it is in 10 or 15 months. So instead of trying to turn cow-shit into high octane fuel, we are going to have to learn to get off the road, and that is just what happened. In 2009, there were 4 million fewer cars on the road than there were the year before. In the next ten years, 40 million North Americans will be taking the exit lanes. The question is, “Will there be a bus to get on?” Instead of giving $40 billon to General Motors, what we should have done is spend $40 billion on public transit, so there would be a bus to get on.

In a world of triple digit oil prices, all of the sudden the economy’s speed limit changes. And that is one of the problems that we have here in America, is that we don’t recognize that our economy’s speed limit has changed. What the economy could grow at when oil was $20 to $30 barrel is a whole different speed limit than what the US economy can grow at when oil is $80 to $150 barrel.

And that is something that I don’t think the Administration recognizes. President Obama cannot get cheap oil. He can get expensive oil. We can build a pipeline from the Canadian tar sands down to the Gulf refineries, and we can get oil. But in order to get the kind of oil that will be required, that will require the triple digit oil prices that we can’t afford to pay. Trying to prime the economy with fiscal stimulus is not a substitute for cheap oil. It won’t make the economy grow any faster. It will just make the deficit that much bigger.

Worse than that, triple digit oil prices will not only take millions off the road, it will send our economy right back into recession. We can’t do a whole lot about triple digit oil prices.


Posted in Energy Markets | Leave a comment


Back-Office Blues 

Nov 8, 2010. James Surowiecki. The New Yorker.

In the late 1960s, Wall Street was crippled by an unlikely nemesis: unfinished paperwork. Thanks to a booming stock market, trading volume had soared in the course of the decade; between 1960 and 1968, the number of shares traded daily quadrupled. This should have been wonderful news for brokerage houses—more trades mean more commissions—but it ended up wrecking many of them instead. Because brokerages were slow to add workers and update back-office operations, they were literally buried beneath all the new business—offices were full of stock certificates, and trade documents were stacked halfway to the ceiling. Amid the chaos, dividend checks went unsent, trades were credited to the wrong accounts, and fraud spread; hundreds of millions of dollars in securities were stolen. And since the firms often didn’t process trades quickly enough, billions of dollars’ worth of transactions a month were simply cancelled. In 1968, the stock market started closing one day a week to let firms catch up on their work, but the brokerages’ bookkeeping woes caught up to them first, and more than a hundred firms went under. It took years—and the passage of an investor-protection bill—for the crisis to abate.

You’d think the Street would have learned its lesson. Instead, it’s now threatened by an even bigger back-office crisis: Foreclosuregate. Banks, faced with a flood of delinquent mortgages resulting from the bad loans they made during the housing bubble, have done exactly what the brokerages did forty years ago: they’ve cut corners. They’ve foreclosed on homes without having the proper documentation, and relied on unqualified people to sign affidavits attesting to things they didn’t know—so-called “robosigners.” In a few cases, they seem to have actually tossed people who didn’t have mortgages out of their homes. As a result, federal regulators and attorneys general in all fifty states are now investigating. And, in the weeks since the scandal first erupted, other issues have appeared, calling into question the legitimacy of the way mortgages were packaged and sold, and raising the possibility that the banks might have to buy back piles of bad mortgages. Forecasts of “catastrophe,” “Armageddon,” and “apocalypse” have now become routine.

There’s no doubt that it’s a brutal mess. The banks have been servicing mortgages and chasing delinquents with the same carelessness and indifference to due process that they demonstrated when they underwrote and securitized the mortgages in the first place. A foreclosing bank should be able, at a minimum, to produce the original mortgage note to demonstrate that it has the right to foreclose. But many banks have been unwilling or unable to do so. The same goes for other documentation: in a study of seventeen hundred cases of foreclosure in bankruptcy, Katherine Porter, a law professor at the University of Iowa, found that necessary documents were missing in more than half of them. Servicing mortgages well means hiring and training lots of workers to help customers, modify loans, and insure that documents are in order. But that costs money, and since mortgage servicing is already a low-margin business, banks have preferred to do things on the cheap, which is an open invitation to trouble, including fraud. To those responsible, a bit of sloppy paperwork probably seemed like no big deal, but when you’re talking about taking away people’s homes paperwork and due process should matter quite a bit.

All the same, the widespread proclamations of Armageddon seem overblown. The banks’ behavior has been appalling, but the crisis probably won’t be fatal for them, however much some of them might deserve that. Criminal charges are likely, and justified. And judges are already looking more skeptically at banks’ legal claims. But we aren’t going to see a Jubilee for debtors. The actual debts are almost all real, and the records of most of them presumably exist somewhere. So some financial institution will eventually end up with the right to foreclose, even though getting there will be expensive and time-consuming. And while banks may suffer considerable losses—having to spend tens of billions of dollars to buy back mortgages that violated the warranties they made to investors—forcing them to do this will take a long time, and enable them to spread the pain out over years. Nor is the uproar going to lead millions of homeowners to stop paying their mortgages. Predictions of catastrophe are understandable—the memory of the banking crisis is fresh, and it seems like poetic justice—but we’re probably not going to see apocalypse redux.

Indeed, there’s a chance that in the long run the banks’ travails could make things better for the economy, not worse. For a start, all the sand in the gears of the foreclosure mills will make it easier for delinquent borrowers to stay in their homes—not so bad an outcome, in economic terms, as the banks would have us believe. There are eleven months of existing-home inventory for sale right now; dumping another million foreclosed homes onto the market hardly seems economically essential. More important, making foreclosures tougher to get and more expensive to process could push banks to get serious about modifying mortgages, which at this point is the best route to getting the housing market back in reasonable shape. Up to now, it’s often been easier and cheaper for banks to foreclose, and mortgage servicers commonly make more in foreclosure than in modification. But being forced to follow the law before foreclosing, and having the threat of criminal investigation over their heads, may change that calculus. (More government pressure wouldn’t hurt, either.) The back-office crisis of the nineteen-sixties compelled Wall Street to do a better job of protecting and serving investors. It’d be fitting if Foreclosuregate ended up doing the same for homeowners.

Other articles about foreclosure scandal:

Oct 13, 2010. The Second Leg Down of America’s Death Spiral   Gonzalolira blog.


Posted in Mortgages | Leave a comment

Automaticearth World View

Here is an updated distillation of our worldview.

The Resurgence of Risk, which appeared at The Oil Drum Canada in August 2007 provides the background to how we came to be in our present predicament. It is by far the longest of the primers, and its purpose is to explain in some depth the nature of our credit bubble, the role of ‘financial innovation’, the distinction between currency inflation and credit hyper-expansion and the mechanism by which value disappears as a bubble deflates.

For further explanation of the ponzi nature of bubbles, the spectrum of ponzi dynamics underlying many economic phenomena and the implications of this for where we are headed, see From the Top of the Great Pyramid.

This ties in with an earlier piece from The Oil Drum Canada, Entropy and Empire , detailing the progression of hegemonic power from empire to empire, as each rises, over-reaches, falls and passes the mantle on to its successor.

The political picture is further developed in Economics and the Nature of Political Crisis, with a more specific look at Europe in The Imperial Eurozone (With all That Implies).

When bubbles reach their maximum extent, they invariably deflate. Our explanation as to why this is inevitable can be found in Inflation Deflated, followed by, The Unbearable Mightiness of Deflation, a rebuttal to inflationist Gary North. An Interview with Stoneleigh provides a more recent and more comprehensive piece on deflation and its consequences.

We dispute classical economic theory and the received wisdom as to the nature of markets. Markets are not objective, mechanical and rational as the Efficient Market Hypothesis would have you believe. Our explanation of markets as human phenomena grounded in destabilizing positive feedback can be found in Markets and the Lemming Factor (with kudos to Robert Prechter, who has been developing the hugely important theory of socionomics for many years).

We have a number of articles on specific aspects of our current crisis. Our view of real estate can be found in Welcome to the Gingerbread Hotel. Employment is covered in War in the Labour Markets.

The Special Relativity of Currencies and Dollar-Denominated Debt Deflation address our view of currency inter-relationships and the value of currency relative to available goods and services.

Our view of the intersection between peak oil and finance can be found in Energy, Finance and Hegemonic Power  and Oil, Credit and the Velocity of Money Revisited, and our view of the future of power systems is explained in Renewable Power? Not in Your Lifetime  and A Green Energy Revolution?.

Our take on the future for gold can be found in A Golden Double-Edged Sword, and our view of -global- trade is covered in The Rise and Fall of Trade.

Our predictions for the future in a nutshell are available in point form in 40 Ways to Lose Your Future .

Our prescription for facing the future is presented in How to Build a Lifeboat .

This is our attempt to convey what we as individuals can hope to do about it for ourselves, our families and friends. We cannot avoid living through a Greater Depression, but we can take action, and, being forewarned, we can hopefully avoid many pitfalls. We can attempt to avoid becoming part of the herd that is determined to throw itself off a cliff.

Finally, our most theoretical piece, Fractal Adaptive Cycles in Natural and Human Systems, connects ecological and socioeconomic cycles through an analogous framework, drawing together the work of CS Holling, Robert Prechter and Joseph Tainter. The big picture is of crucial importance as we have reached, and passed, the pinnacle of a golden age. We are moving into an era of uncertainty and upheaval such as none of us have hitherto experienced but all of us must try to navigate successfully.

We at The Automatic Earth will continue to provide what assistance we can with that process. The TAE world tour continues, with a view to turning virtual communities into real ones. By popular demand, we will shortly be making available a recording of one of these presentations. Watch this space.

Posted in Nicole Foss | Leave a comment

Ashvin Pandurangi on social disorder and the military

The Debt-Dollar Discipline: Part III – Future Reorganization

Dec 13, 2010. Ashvin Pandurangi

[giant snips and rearrangement of material]

Machines of societal oppression, whether they are equipment or computerized devices, cannot continue to function at their current rates of activity without access to increasing amounts of net energy. Currently, there are no forms of renewable energy or technologies of energy efficiency in place which could realistically offset the terminal declines in net energy faced by global society. The time after which a wide-scale implementation of such energy infrastructure becomes impossible is approaching very soon, if it has not already passed.

It is significantly likely that developed societies will re-organize at much smaller scales of economic and political activity, in which states, cities and local communities become more important to the “individual” than regional blocs or even nations. People will be forced to rely on their immediate environments as a means of acquiring basic goods and services. The mechanisms of discipline and control, if they exist at all, will only be able to operate within a localized range for limited purposes.

This scenario should not be taken lightly, however, because it will certainly involve a transitional period rife with disorder and violence. These symptoms are especially likely if there is an initial period of physical conflict between governmental power structures and their resistant populations, which should be expected. Although the increasingly impoverished citizenry of the world obviously outnumber the disciplinary elites by a large factor, these elites have a not-so-secret weapon to combat many of the obstacles mentioned above.

The roots of discipline can be traced back to the army, which, throughout history, has disciplined its soldiers to be obedient, self-regulating and deadly efficient by implementing strict restrictions on their movement through time and space. Everything about a soldier’s existence in the barracks is tightly controlled through confined quarters, strict daily schedules, drill exercises, required conduct, etc. Although modern global society is publicly characterized as a place of diplomacy and peaceful negotiation, it has actually retained the most deadly military forces with the most deadly weaponry to match.

The U.S. military, for example, may eventually face a legitimacy crisis of its own, but the unwavering loyalty of its commanders and soldiers should not be underestimated. The structures of command within the military are kept almost entirely under the purview of the executive branch, and this design will make it difficult for elements of popular dissent to infiltrate its operations. After all, it is only natural that the institution to first, and most powerfully, implement disciplinary principles within human civilization should be the last to lose that disciplinary character.

In this sense, military institutions and arsenals provide the last line of “defense” for desperate power structures battling the scarcity of vital resources and the chaos of popular dissent.

The U.S. has already strategically positioned its military throughout the Middle East, which is obviously the most oil-rich region in the world. When availability and expense begin threatening the U.S. share of global oil production, these forces can be readily mobilized to secure production facilities and trade routes.

It is also most likely the case that detailed plans are already in place to institute martial law on the American population in the event of disciplinary break down. A program called “Unified Quest 2011″, consisting of war games, seminars, workshops and conferences, is self-described as being “the Army Chief of Staff’s primary mechanism to explore enduring challenges and the conduct of operations in a future operational environment”. It would be naive to assume that American states and cities are not some of the “future operational environments” that they are preparing to conduct operations in. The government, of course, will insist that it is simply maintaining stability and doing what’s best for its citizens, but the crucial question is whether the masses will voluntarily submit.

The U.S. citizenry is the most heavily armed in the world (90 guns per 100 people, and they may refuse to submit without a fight. The American people were more than willing to relinquish many of their Constitutional rights after 9/11 for the sake of perceived security, but this time the circumstances will be drastically different. There will be millions of painfully destitute people, who possess rapidly diminishing faith in their government’s ability to aid or protect them, and have precious little to lose from active resistance. During the chaotic, unpredictable release of a complex system, even the best laid schemes of disciplinary governments and their military forces could go awry.

Posted in By People, Social Disorder | Leave a comment

Why do people fall for Ponzi and other schemes?

Fooled by Ponzi (and Madoff). How Bernard Madoff Made Off with My Money 

Dec 23, 2008. Stephen Greenspan. Skeptic.com

There are few areas of functioning where skepticism is more important than how one invests one’s life savings. Yet intelligent and educated people, some of them naïve about finance and others quite knowledgeable, have been ruined by schemes that turned out to be highly dubious and quite often fraudulent. The most dramatic example of this in American history is the recent announcement that Bernard Madoff, a highly-regarded hedge fund manager and a former president of NASDAQ, has for several years been running a very sophisticated Ponzi scheme which by his own admission has defrauded wealthy investors, charities and other funds, of at least 50 billion dollars.

In my new book Annals of Gullibility1, I analyze the topic of financial scams, along with a great number of other forms of human gullibility, including war (the Trojan Horse), politics (WMDs in Iraq), relationships (sexual seduction), pathological science (cold fusion), religion (Christian Science), human services (Facilitated Communication), medical fads (homeopathy), etc. Although gullibility has long been of interest in works of fiction (Othello, Pinnochio), religious documents (Adam and Eve, Samson) and folk tales (Emperor’s New Clothes, Little Riding Hood), it has been almost completely ignored by social scientists. There have been a few books that have focused on narrow aspects of gullibility, including Charles Mackey’s classic 19th century book, Extraordinary Popular Delusion and the Madness of Crowds (most notably on investment follies such as Tulipimania, in which rich Dutch people traded their houses for one or two tulip bulbs).2 In Annals of Gullibility I propose a multi-dimensional theory that would explain why so many people behave in a manner which exposes them to severe and predictable risks. This includes myself — I lost a good chunk of my retirement savings to Mr. Madoff, so I know of what I write on the most personal level.

Ponzi Schemes & Other Investment Manias & Frauds

Although my focus here is on Ponzi schemes, I shall also briefly address the topic of investment manias (such as the dot.com bubble) and other forms of financial fraud (such as various inheritance scams). That is because they all involve exploitation of investor gullibility and can all be explained by the same theoretical framework.

A Ponzi scheme is a fraud where invested money is pocketed by the schemer and investors who wish to redeem their money are actually paid out of proceeds from new investors. As long as new investments are expanding at a healthy rate, the schemer is able to keep the fraud going. Once investments begin to contract, as through a run on the company, then the house of cards quickly collapses. That is what happened with the Madoff scam when too many investors — needing cash because of the general U.S. financial meltdown in late 2008 — tried to redeem their funds. Madoff could not meet these demands and the scam was exposed.

The scheme gets its name from Charles Ponzi,3 an Italian immigrant to Boston, who in 1920 came up with the idea of promising huge returns (50% in 45 days) supposedly based on an arbitrage plan (buying in one market and selling in another) involving international postal reply coupons. The profits allegedly came from differences in exchange rates between the selling and the receiving country (where they could be cashed in). A craze ensued, and Ponzi pocketed many millions of dollars, most from poor and unsophisticated Italian immigrants in New England and New Jersey. The scheme collapsed when newspaper articles began to raise questions about it (pointing out, for example, that there were not nearly enough such coupons in circulation) and a run occurred.

The basic mechanism explaining the success of Ponzi schemes is the tendency of humans to model their actions (especially when dealing with matters they don’t fully understand) on the behavior of other humans. This mechanism has been termed “irrational exuberance,” a phrase attributed to former fed chairman Alan Greenspan (no relation), but actually coined by another economist, Robert J. Schiller in a book with that title. Schiller employs a social psychological explanation that he terms the “feedback loop theory of investor bubbles.” Simply stated, the fact that so many people seem to be making big profits on the investment, and telling others about their good fortune, makes the investment seem safe and too good to pass up. In Schiller’s words, the fact “that others have made a lot of money appears to many people as the most persuasive evidence in support of the investment story associated with the Ponzi scheme — evidence that outweighs even the most carefully reasoned argument against the story.”4

In Schiller’s view, all investment crazes, even ones that are not fraudulent, can be explained by this theory. Two modern examples of that phenomenon are the Japanese real estate bubble of the 1980s and the American dot.com bubble of the 1990s. Two 18th century predecessors were the Mississippi Mania in France and the South Sea Bubble in England (so much for the idea of human progress). In all of these cases, the thing that kept the mania going was the thought “when so many leading members of society believe in and seem to profit from a course of action, how can it possibly be risky or dangerous?”

A form of investment fraud that has structural similarities to a Ponzi scheme is an inheritance scam, in which a purported heir to a huge fortune is asking for a short-term investment in order to clear up some legal difficulties involving the inheritance. In return for this short-term investment, the investor is promised enormous returns. The best-known modern version of this fraud involves use of the internet, and is known as a “419 scam,” so named because that is the penal code number covering the scam in Nigeria, the country from which most of these internet messages originate. The 419 scam differs from a Ponzi scheme in that there is no social pressure brought by having friends who are getting rich. Instead, the only social pressure comes from an unknown correspondent, who undoubtedly is using an alias. Thus, in a 419 scam, other factors, such as psychopathology or extreme naïvete, likely explain the gullible behavior, as seen in a profile of such a highly-trusting victim, nicknamed “the perfect mark,” by Mitchell Zuckoff.5

Two historic versions of the inheritance fraud that are equal to the Madoff scandal in their widespread public success, and that relied equally on social feedback processes, occurred in France in the 1880s and 1890s, and in the American Midwest in the 1920s and 1930s. The French scam was perpetrated by a talented French hustler named Therese Humbert, who claimed to be the heir to the fortune of a rich American, Robert Henry Crawford, whose bequest reflected gratitude for her nursing him back to health after he suffered a heart attack on a train. The will had to be locked in a safe for a few years until Humbert’s youngest sister was old enough to marry one of Crawford’s nephews. In the meantime, leaders of French society were eager to get in on this deal, and their investments (including by one countess, who donated her chateau) made it possible for Humbert — who milked this thing for 20 years — to live in a high style. Success of this fraud, which in France was described as “the greatest scandal of the century” was kept going by the fact that Humbert’s father-in-law was a respected jurist and politician in France’s Third Republic and he publicly reassured investors, who included the cream of French society.6

The American version of the inheritance scam was perpetrated by a former Illinois farm boy named Oscar Hartzell. While Therese Humbert’s victims were a few dozen extremely wealthy and worldly French aristocrats, Hartzell swindled over 100,000 relatively unworldly farmers and shopkeepers throughout the American heartland. The basic claim — as described by Jay Robert Nash7 and Richard Rayner8 — was that the English seafarer, Sir Francis Drake, had died without any children, but that a will had been recently located (in one version, in a church belfry). The heir to the estate, which was now said to be worth billions (from compounding of the value of loot accumulated when Drake was a privateer plundering the Spanish Main), was a colonel Drexel Drake in London. As the colonel was about to marry his extremely wealthy niece, he wasn’t interested in the estate, which needed some adjudication, and turned his interest over to Hartzell, who now referred to himself as “Baron Buckland.” The Drake scheme became a social movement, known as “the Drakers” (later changed to “the Donators”) and whole churches and groups of friends — some of whom planned to found a utopian commune with the expected proceeds — would gather to read the latest Hartzell letters from London. Hartzell was eventually indicted for fraud and brought to trial in Iowa, over great protest by his thousands of loyal investors. Rayner noted that what “had begun as a speculation had turned into a holy cause.”

A Multidimensional Theory of Investment & Other Forms of Gullibility

While social feedback loops are an obvious contributor to understanding the success of Ponzi and other mass financial manias, one needs to also look at factors located in the dupes themselves that might help to explain why they fell prey to the social pressure while others did not. There are four factors in my explanatory model, which can be used to understand acts of gullibility but also other forms of what I term “foolish action.”9 A foolish (or stupid) act is one where someone goes ahead with a socially or physically risky behavior in spite of danger signs, or unresolved questions, which should have been a source of concern for the actor. Gullibility is a sub-type of foolish action, which might be termed “induced-social.” It is induced because it always occurs in the presence of pressure or deception by one or more other people. Social foolishness can also take a non-induced form, as when someone tells a very inappropriate joke that causes a job interview or sales meeting to end unsuccessfully. Foolishness can also take a “practical” (physical) form, as when someone lights up a cigarette in a closed car with a gas can in the back seat and ends up incinerating himself. As noted, the same four factors can be used to explain all foolish acts, but in the remainder of this paper I shall use them to explain Ponzi schemes, particularly the Madoff debacle.

The four factors are situation, cognition, personality and emotion. Obviously, individuals differ in the weights affecting any given gullible act. While I believe that all four factors contributed to most decisions to invest in the Madoff scheme, in some cases personality should be given more weight while in other cases emotion should be given more weight, and so on. As mentioned, I was a participant — and victim — of the Madoff scam, and have a pretty good understanding of the factors that caused me to behave foolishly. So I shall use myself as a case study to illustrate how even a well-educated (I’m a college professor) and relatively intelligent person, and an expert on gullibility and financial scams to boot, could fall prey to a hustler such as Madoff.


Every gullible act occurs in a particular micro-context, in which an individual is presented with a social challenge that he has to solve. In the case of a financial decision, the challenge is typically whether to agree to an investment decision that is being presented to you as benign but that may pose severe risks or otherwise not be in one’s best interest. Assuming (as with the Madoff scam) that the decision to proceed would be a very risky and thus foolish act, a gullible behavior is more likely to occur if the social and other situational pressures are strong and less likely to occur if the social and other situational pressures are weak, or balanced by countervailing pressures (such as having wise heads around to warn you against taking the plunge).

The Madoff scam had social feedback pressures that were very strong, almost rising to the level of the “Donators” cult around the Drake inheritance fraud. A December 15, 2008 New York Times article described how wealthy retirees in Florida joined Madoff’s country club for the sole reason of having an opportunity to meet him socially and be invited to invest directly with him.10 Most of these investors, as well as Madoff’s sales representatives, were Jewish, and it appears that the Madoff scheme was seen as a safe haven for well-off Jews to park their nest eggs. The fact that Madoff was a prominent Jewish philanthropist was undoubtedly another situational contributor, as it likely was seen as highly unlikely that such a person would be scamming fellow Jews (which included many prominent Jewish charities, some of them now forced to close their doors).

A non-social situational aspect that contributed to a gullible investment decision was, paradoxically, that Madoff promised modest rather than spectacular gains. Sophisticated investors would have been highly suspicious of a promise of gains as spectacular as those promised almost 100 years earlier by Charles Ponzi. Thus, a big part of Madoff’s success came from his recognition that wealthy investors were looking for small but steady returns, high enough to be attractive but not so high as to arouse suspicion. This was certainly one of the things that attracted me to the Madoff scheme, as I was looking for a non-volatile investment that would enable me to preserve and gradually build wealth in down as well as up markets.

Another situational factor that pulled me in was the fact that I, along with most Madoff investors (except for the super-rich) did not invest directly with Madoff but went through one of 15 “feeder” hedge funds that then turned all of their assets over to Madoff to manage. In fact, I am not certain if Madoff’s name was even mentioned (and certainly, I would not have recognized it) when I was considering investing in the (three billion dollar) “Rye Prime Bond Fund” that was part of the respected Tremont family of funds, which is itself a subsidiary of insurance giant Mass Mutual Life. Thus, I was dealing with some very reputable financial firms, which created the strong impression that this investment had been well-researched and posed acceptable risks.

The micro social context in which I made the decision to invest in the Rye fund came about when I was visiting my sister and brother-in-law in Boca Raton, Florida and met a close friend of theirs who is a financial adviser who was authorized to sign people up to participate in the Rye (Madoff-managed) fund. I genuinely liked and trusted this man, and was persuaded by his claim that he had put all of his own (very substantial) assets in the fund, and had even refinanced his house and placed all of the proceeds in the fund. I later met many friends of my sister who were participating in the fund. The very successful experience they had over a period of several years convinced me that I would be foolish not to take advantage of this opportunity. My belief in the wisdom of this course of action was so strong that when a skeptical (and financially savvy) friend back in Colorado warned me against the investment, I chalked the warning up to his sometime tendency towards knee-jerk cynicism.


Gullibility can be considered a form of stupidity, so it is safe to assume that deficiencies in knowledge and/or clear thinking often are implicated in a gullible act. By terming this factor “cognition” rather than intelligence, I mean to indicate that one can have a high IQ and still prove gullible. There is a large literature, by scholars such as Michael Shermer11 and Massimo Piattelli-Palmarini12 that show how often people of average and above-average intelligence fail to use their intelligence fully or efficiently when addressing everyday decisions. Keith Stanovich makes a distinction between intelligence (the possession of cognitive schemas) and rationality (the actual application of those schemas).13 The “pump” that drives irrational decisions (many of them gullible), according to Stanovich, is the use of intuitive, impulsive and non-reflective cognitive styles, often driven by emotion.

In my own case, the decision to invest in the Rye fund reflected both my profound ignorance of finance, and my somewhat lazy unwillingness to remedy that ignorance. To get around my lack of financial knowledge and my lazy cognitive style around finance, I had come up with the heuristic of identifying more financially knowledgeable advisers and trusting in their judgment and recommendations. This heuristic had worked for me in the past and I had no reason to doubt that it would work for me in this case.

The real mystery in the Madoff story is not how naïve individual investors such as myself would think the investment safe, but how the risks and warning signs could have been ignored by so many financially knowledgeable people, ranging from the adviser who sold me and my sister (and himself) on the investment, to the highly compensated executives who ran the various feeder funds that kept the Madoff ship afloat. The partial answer is that Madoff’s investment algorithm (along with other aspects of his organization) was a closely guarded secret difficult to penetrate, and partly (as in all cases of gullibility) that strong affective and self-deception processes were at work. In other words, they had too good a thing going, for themselves and their clients, to entertain the idea that it might all be about to crumble.


Gullibility is sometimes equated with trust, but the late psychologist Julian Rotter showed that not all highly trusting people are gullible.14 The key to survival in a world filled with fakers (Madoff) or unintended misleaders who were themselves gulls (my adviser and the managers of the Rye fund) is to know when to be trusting and when not to be. I happen to be a highly trusting person who also doesn’t like to say “no” (such as to a sales person who had given me an hour or two of his time). The need to be a nice guy who always says “yes” is, unfortunately, not usually a good basis for making a decision that could jeopardize one’s financial security. In my own case, trust and niceness were also accompanied by an occasional tendency towards risk-taking and impulsive decision-making, personality traits that can also get one in trouble.


Emotion enters into virtually every gullible act. In the case of investment in a Ponzi scheme, the emotion that motivates gullible behavior is a strong wish to increase and protect one’s wealth. In some individuals, this undoubtedly takes the form of greed, but I think that truly greedy individuals would likely not have been interested in the slow but steady returns posted by the Madoff-run funds. I know that in my case, I was excited not by the prospect of striking it rich but by the prospect of having found an investment that promised me the opportunity to build and maintain enough wealth to have a secure and happy retirement. My sister, a big victim of the scam, put it well when she wrote that “I suppose it was greed on some level. I could have bought CDs or municipal bonds and played it safer for less returns. The problem today is there doesn’t seem to be a whole lot one can rely on, so you gravitate towards the thing that in your experience has been the safest. I know somebody who put all his money in Freddie Macs and Fannie Maes. After the fact he said he knew the government would bail them out if anything happened. Lucky or smart? He’s a retired securities attorney. I should have followed his lead, but what did I know?”15


I suspect that one reason why psychologists and other social scientists have avoided studying gullibility is because it is affected by so many factors, and is so micro-context dependent that it is impossible to predict whether and under what circumstances a person will behave gullibly. A related problem is that the most catastrophic examples of gullibility (such as losing one’s life savings in a scam) are low frequency behaviors that may only happen once or twice in one’s lifetime. While as a rule I tend to be a skeptic about claims that seem too good to be true, the chance to invest in a Madoff-run fund was one case where a host of factors — situational, cognitive, personality and emotional — came together to cause me to put my critical faculties on the shelf.

Skepticism is generally discussed as protection against beliefs (UFOs) or practices (Feng Shui) that are irrational but not necessarily harmful. Occasionally, one runs across a situation where skepticism can help you to avoid a disaster as major as losing one’s life (being sucked into a crime) or one’s life savings (being suckered into a risky investment). Survival in the world requires one to be able to recognize, analyze, and escape from those highly dangerous situations.

So should one feel pity or blame towards those who were insufficiently skeptical about Madoff and his scheme? A problem here is that the lie perpetrated by Madoff was not all that obvious or easy to recognize (in fact, it is very likely that Madoff’s operation was legitimate initially but took the Ponzi route when he began to suffer losses that he was too proud to acknowledge). Virtually 100% of the people who turned their hard-earned money (or charity endowments) over to Madoff would have had a good laugh if contacted by someone pitching a Nigerian inheritance investment or the chance to buy Florida swampland. Being non-gullible ultimately boils down to an ability to recognize hidden social (or in this case, economic) risks, but some risks are more hidden and, thus, trickier to recognize than others. Very few people possess the knowledge or inclination to perform an in-depth analysis of every investment opportunity they are considering. It is for this reason that we rely on others to help make such decisions, whether it be an adviser we consider competent or the fund managers who are supposed to oversee the investment.

I think it would be too easy to say that a skeptical person would and should have avoided investing in a Madoff fund. The big mistake here was in throwing all caution to the wind, as in the stories of many people (some quite elderly) who invested every last dollar with Madoff or one of his feeder funds. Such blind faith in one person, or investment scheme, has something of a religious quality to it, not unlike the continued faith that many of the “Drakers” continued to have in Oscar Hartzell even after the fraudulent nature of his scheme began to become very evident. So the skeptical course of action would have been not to avoid a Madoff investment entirely but to ensure that one maintained a sufficient safety net in the event (however low a probability it might have seemed) that Madoff turned out to be not the Messiah but Satan. As I avoided drinking a full glass of Madoff Kool-aid, maybe I’m not as lacking in wisdom as I thought.

Stephen Greenspan is a psychologist who is Clinical Professor of Psychiatry at the University of Colorado. His website is www.stephen-greenspan.com.

  1. Greenspan, S. 2009. Annals of Gullibility: Why We are Duped and How to Avoid it. Westport, CT: Praeger.
  2. Mackey, C. 1841. Extraordinary Popular Delusions and the Madness of Crowds. London: Richard Bentley.
  3. Zuckoff, M. 2005. Ponzi’s Scheme: The True Story of a Financial Legend. Random House: New York.
  4. Schiller, R. J. 2000. Irrational Exuberance. Princeton, NJ: Princeton University Press, p. 66.
  5. Zuckoff, M. 2006. “The Perfect Mark: How a Massachusetts Psychotherapist Fell for a Nigerian e-mail Scam.” New Yorker, p. 6.
  6. Spurling, H. 2000. La grande Therese: The Greatest Scandal of the Century. New York: HarperCollins.
  7. Nash, J. R. 1976. Hustlers and Con Men: An Anecdotal History of the Confidence Man and His Games. New York: M. Evans & Co.
  8. Rayner, R. 2002. “The Admiral and the Con Man.” New Yorker, April 22 & 29, pp. 150-161.
  9. Greenspan, S. 2009. “Foolish Action in Adults with Intellectual Disabilities: The Forgotten Problem of Risk-Unawareness.” In L. M. Glidden (Ed.), International Review of Research in Mental Retardation. Vol. 36 (pp. 147–194). NY: Elsevier.
  10. Urbina, I. 2008. “A Palm Beach enclave stunned by an inside job. The New York Times, December 15, pp. B1, B3.
  11. Shermer, M. 1997. Why People Believe Weird Things: Pseudoscience, Superstition, and Other Confusions of Our Time. New York: W.H. Freeman.
  12. Piattelli-Palmarini, M. 1994. Inevitable Illusions: How Mistakes of Reason Rule Our Minds. New York: Wiley.
  13. Stanovich, K. E. 1999. Who is Rational? Studies of Individual Differences in Reasoning. Mahwah, NJ: Erlbaum.
  14. Rotter, J. B. 1980. “Interpersonal Trust, Trustworthiness and Gullibility.” American Psychologist, 35, 1–7.
  15. Zitrin, P. S. 2008. E-mail communication. Boca Raton, FL, December 15.
Posted in Ponzi Schemes | Leave a comment

Sovereign Default predictions

Matt Mushalik: Links Between Peak Oil and Financial Crisis; also Updated Graphs

Feb 1, 2009. A comment by WNC Observer on this post. theoildrum.com

My guess is that a US sovereign default is probably not in the cards anytime before 2015, and may not be avoidable anytime much past 2025 or so because:

1. I’ve long felt that 2012/13 was going to be a time period when something pretty serious happens. It is pretty obvious from the present megaproject data that by then, new capacity coming on line starts to fall significantly behind what is needed to replace depletion. Given present oil prices and economic conditions, it is also very likely that we are not going to be seeing a lot more megaprojects entering the pipeline in time to make much of a difference in this. SO, by around 2012, there should be a pretty substantial supply shortage, even if demand continues to be constrained.
2. Based on some of the Export Land Model (ELM) analyses it looks to me that 20 years out (2029) for zero US imports is  probably about the best case  (although the US might still be getting a trickle from Canada then). I’m more inclined to think that China and Japan will use their massive accumulation of US $ and treasuries to lock in long-term supply contracts, thus shutting the US out earlier rather than later.  As for the US using its military to acquire by force what it cannot acquire through legitimate commerce, that is likely to destroy as much or more supply than it will secure.


Having to make huge cuts or even eliminating altogether Social Security and Medicare obligations?


Having to eliminate almost all other federal government programs?


Having to raise federal income taxes or implement at VAT, raising the AVERAGE tax burden to 50% or more?

We are probably less than 4-8 years away – and maybe sooner – from having no choice but to face up to one of these fundamental, painful tradeoff decisions. Maybe we’ll have to accept all of the above in order to keep making payments on our national debt. Are we willing to do that? At what point does sovereign default start to look not quite so painful or unthinkable after all?

Of course, once The Powers That Be finally realize that we’ve only got a few more years of imports coming in any case, and once they’ve finally come clean with the general public about this, then a lot of the downsides of sovereign default start looking a lot less painful.


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One year Moratorium on Mortgages

Ilargi Feb 2, 2009   http://www.theautomaticearth.com/

[As Dmitry Orlov points out in Dmitry Orlov: How Russians survived the collapse of the Soviet Union "In the Soviet Union, nobody owned their place of residence. What this meant is that the economy could collapse without causing homelessness: just about everyone went on living in the same place as before. There were no evictions or foreclosures. Everyone stayed put, and this prevented society from disintegrating. One more difference: the place where they stayed put was generally accessible by public transportation, which continued to run during the worst of times. Most of the Soviet-era developments were centrally planned, and central planners do not like sprawl: it is too difficult and expensive to service. Few people owned cars, and even fewer depended on cars for getting around."]

Here’s an idea I’ve been toying with lately: A 1 year moratorium on mortgages, in the US, EU and UK. That’s right, no new mortgages would be written for the next 12 months. I am fully aware of the weight of the voice of established banks, and what that means for the chances of an idea like this. But please bear with me.

My idea would mean the end for the best part of an entire industry, I know. But then, that industry is only alive because of government support. Fannie and Freddie should be dead entities, but nothing is ever truly dead that feeds on the public vein. What you can do with the $10.6 trillion in Fannie&Freddie mortgage holdings in this: any foreclosure-worthy loan is donated by the federal government to the municipality the home is in. In other words, the community now owns the home, and can decide to leave the occupants in the home. Or not. yes, this will devalue all homes in the community. But that will happen anyway. the advantage is that people can be kept in their homes.

If you have a 1 year mortgage moratorium, you’ll effectively steer yourselves towards a situation in which people cannot buy homes, they can only rent them. But increasingly, they will then rent from the community they are part of. And that harks back to the principle that communities need to keep control of their citizens’ basic needs as much as possible. We are talking, in that sense, about the best or all worlds. Why should homes by private property that only enriches bankers and carries the risk the owners treat their properties in ways that hurt the community. I know that Americans will cry “Socialism” now, but that’s fine by me. Americans have no idea what socialism means anyway.

There are huge advantages for everyone in a system where basic needs are property of the community, not individuals. The biggest advantages, ironically, are for the individual. In our present system, paying off a $100k mortgage in full costs you $300-400k. And that is money that leaves your community, since the main lenders are not local. If you can pay much less per month, and the money you do pay stays inside your community, you have a situation in which everyone wins except for the fat cat bankers.

Anyway, I should let go of the stream of consciousness for now and start posting this. I’ll get back to it one of these days. The British notion of establishing a national bank that belongs to the people, if combined with a way to keep people in their homes that does not hurt their own neighbors, looks to me to be the only way forward. Unfortunately, what I see in the US, and across the board, is only concerned with raising the dead (banks). That will not work. My ideas are far more promising than Obama’s so far. So there you are and here you go.

Feb 19, 2009

The president’s $275 billion plans to halt foreclosures are even more twisted. If you can afford your mortgage, or if you rent, you are now a sucker all of a sudden. The real suckers who are presently underwater or close to eviction are elevated to worthy of saving status. There is, however, not a word about what happens to the worthy former suckers when home values keep going down. And they will. What are we going to do, renegotiate every year?

The fact of the matter, of course, is that the $275 billion will not, and are not meant to, benefit the homeowners. They are provided for the benefit of the lenders, the banks. They are meant to guarantee an ongoing flow of funds towards the vaults replete with toxic debts based on the very homes the government now showers with cash. They are meant to artificially continue to prop up US real estate values, which, if they were allowed to simply follow the course of the markets, would bankrupt not only the owners, for which Washington cares preciously little, but also the banks, for which Washington will bend over backwards any time of day. The main problem is that it’s way too late. The banks will drown, and everybody knows it. So the only real purpose served by these measures is to transfer ever more of the public’s funds to the banking sector. It’ll go on until the nation itself is completely broke and broken.

What would be in the real interest of the people is to let the banks fail, and use these funds to set up a new banking system. There are various ways to do this. Nationalizing the banks is not one of them, because it would transfer the toxic debts to the people. Who are already poor and getting much poorer even without those “assets”. It can’t be done. There is no way. Tim Geithner couldn’t do it after 19 months of thinking, and nobody else can. The banks must be made to fail. But they won’t be, because the main shareholders, who are among the richest people on the planet, would never allow it. At least not now. They prefer opening the public spigot more and more, until it breaks. Since they own Washington, that is what will happen.

Another hypothetical -since it won’t be accepted- issue that would be in the public’s interest is that Fannie and Freddie should be liquidated. Not made even bigger, as Obama is set to do. Fannie and Freddie are both perverted and perverting institutions. They keep home prices artificially high, which is good for banks, and banks only. All homes in foreclosure process that the two GSE’s hold should be handed over to the communities they are located in. Nationalize those properties, not the banks. Under very strict regulations, which are necessary to prevent them from turning into objects of political power ploys, the homes, in which the former owners can stay, would be properly assessed and the rent the occupants will be forced to pay, if they choose to stay, can flow into the communities they live in. This is the proper and probably only way, not only to keep people in their homes, but also to prevent thousands upon thousands of US communities from going bankrupt.

But it will not come to pass. It would take money away from the owners of the chilled corpses called banks that guide the politics of the nation.

Posted in Mortgages | Leave a comment

Let banks fail, says Nobel economist Joseph Stiglitz

Feb 2, 2009 www.telegraph.co.uk/finance/

The Government should allow every distressed bank to go bankrupt and set up a fresh banking system under temporary state control rather than cripple the country by propping up a corrupt edifice, according to Joseph Stiglitz, the Nobel Prize-winning economist. Professor Stiglitz, the former chair of the White House Council of Economic Advisers, told The Daily Telegraph that Britain should let the banks default on their vast foreign operations and start afresh with new set of healthy banks.

“The UK has been hit hard because the banks took on enormously large liabilities in foreign currencies. Should the British taxpayers have to lower their standard of living for 20 years to pay off mistakes that benefited a small elite?” he said. “There is an argument for letting the banks go bust. It may cause turmoil but it will be a cheaper way to deal with this in the end. The British Parliament never offered a blanket guarantee for all liabilities and derivative positions of these banks,” he said. Mr Stiglitz said the Government should underwrite all deposits to protect the UK’s domestic credit system and safeguard money markets that lubricate lending. It should use the skeletons of the old banks to build a healthier structure. “The new banks will be more credible once they no longer have these liabilities on their back.”

Mr Stiglitz said the City of London would survive the shock of such a default because it would uphold the principle of free market responsibility. “Counter-parties entered into voluntary agreements with the banks and they must accept the consequences,” he said. Such a drastic course of action would be fraught with difficulties and risks, however. It would leave healthy banks in an untenable position since they would have to compete for funds in the markets with state-run entities. Mr Stiglitz’s radical proposal is a “Chapter 11″ scheme for households to allow them to bring their debts under control without having to go into bankruptcy. “Families matter just as much as firms. The US government can borrow at 1pc so why can’t it lend directly to poor people for mortgages at 4pc. ,” he said.

Feb 3, 2009 German news service Deutsche Welle asks Stiglitz:

Q: Economists Nouriel Roubini and Nassim Taleb, who predicted the global economic downturn, have called for a nationalization of banks in order to stop the financial meltdown. Do you agree?

A: The fact of the matter is, the banks are in very bad shape. The U.S. government has poured in hundreds of billions of dollars to very little effect. It is very clear that the banks have failed. American citizens have become majority owners in a very large number of the major banks. But they have no control. Any system where there is a separation of ownership and control is a recipe for disaster. Nationalization is the only answer. These banks are effectively bankrupt.

In 2010 Stiglitz said “What is needed is a quick write-down of the value of the mortgages. Banks will have to recognise the losses and, if necessary, find the additional capital to meet reserve requirements. This, of course, will be painful for banks , but their pain will be nothing in comparison to the suffering they have inflicted on people throughout the rest of the global economy.”

Ilargi at theautomaticearth replies “The reality is though, and it’s hard to believe Stiglitz doesn’t see this, that if mortgage values are written down to realistic levels, i.e. levels that a nation of debt ridden consumers could buy a home at, it wouldn’t just be painful to the banks, it would kill them outright. As it would the US government, which has untold trillions in both mortgages and securities bet on the notion that it can keep those levels up. Neither the government nor the banks, have any intention of letting that happen, unless it becomes inevitable. By which time they wager they’ll have secured as much and as many of their own interests at the cost of the American people as they possibly can.”

Posted in Banking, Banks | Leave a comment

What derivatives are and why you’re screwed

You are the Crisis

Feb 2, 2009 by Ilargi at theautomaticearth

Oh no, we’re not rid of the bad bank drivel yet, are we? I started out trying to make a point about the character of the paper a bad bank, wherever on the planet, would be set up to buy. And I wrote this:

It may well be wise, just so everyone gets a clearer picture of what we are talking about, to stop referring to all this paper as “assets” or “investments”. In this case, these are misleading terms. An asset is something that exists in the real world. A derivative, on the other hand, can best be compared to the paper slip you receive at the racetrack when you place a bet on a horse. That paper slip doesn’t buy you a part of the horse, it buys you the chance of winning an X amount of money if the horse wins the race you’re betting on. When that race is run, you have either won that X amount or you have lost the money the wager has cost you.

Now, that took me back to something I wrote on September 29, 2008, the day the original TARP bail-out was defeated in the House, and the Dow fell 777 points. It was called: Monday at the Racetrack. Allow me please to quote myself, taking into consideration that the big Dow drop came after I wrote it.

(Sep 29 2008) If you go to the racetrack and bet on a horse, you receive a piece of paper that confirms the bet you made. There are many different varieties of bets possible; for now, let’s say you simply bet on one specific horse to win the race. After the race is over, you have either won your bet or lost it. There’s nothing difficult about the process, anyone can -learn to- understand it, and everyone, except in very rare circumstances, accepts it, both the winners and the losers.

What is happening in world finance these days is that a group of very heavy betters have become very heavy losers, and they have done so with borrowed money. In the past few years, in order to hide their losses, they have turned to a very clever little trick: they want to make us believe that the race is not over, even though we can all see that it is. In fact, if they have their way, the race will never be over, unless and until their horse wins.

The US government has joined the argument on the side of the losing betters. They have allowed the losers – who are their friends-, for years, to hide their predicament, their losing tickets, through Level 3 and off-balance sheet “creative accounting”. Now that the government’s betting buddies’ creditors are losing patience, and demand their money back, which the buddies don’t have, the Fed and Treasury want to buy all those losing tickets, with money that belongs to the taxpayers whose best interests they are presumed to represent.

And they up the ante today: the president declares that this will cost the taxpayer nothing; and if you believe that one, you’ll like the guys who claim that there are profits to be made on this avalanche of losing bets. Now there’ll be plenty of “experts” who are more than willing to tell you that comparing mortgage-backed securities –to take just one sort of bet–  with horse racing is inherently flawed. Their argument will be that there is true value behind the securities: the homes that were purchased with the underlying mortgages.

At first glance, that may look plausible: it seems clear that the homes are not all of a sudden worthless, so how could the mortgages and securities be? My first thought is that the horse you bet on is not worthless either just because it lost one race. But that doesn’t make you win your bet, does it? And the horse is still tired. There are deeper problems with the “the home still has value” argument. The most flagrant is the actual purchase prices, which doubled or tripled in a decade, while no value was added to the home itself. From that follows that many homes were sold at prices that people couldn’t truly afford. The US has for that reason already seen millions of foreclosures, with many more inevitably to come. And the elevated prices, of course. are also the ones the securities are based on.

So perhaps at some time in the future your losing horse might win a race, and perhaps at one point some money can be made on a new mortgage for a foreclosed home. But that makes no difference for your losing bet, and neither does it make the securities valuable again. Both races are over. For good. Which makes it impossible for the US taxpayer to play even on the losing betting tickets their government is about to buy with their money, while making a profit on them is too ridiculous to seriously discuss.

If home sales ever recover to any kind of extent, it will be at prices that are far lower than they have been so far in this millenium. That is the only way to make them affordable. And even if it happens, it is going to take years. In the meantime, the gambling losses will have to be paid. Your government tries to convince you that your life will be miserable without their losing betting buddies. If you ask me, it will be much worse with them, because if you want to keep them around, you’ll have to pay their debts. And they’ll just use the money to go bet on the next race. Maybe you should keep the money and buy your own tickets. That way you get to keep the profits too, if there are any.

But if I were you, I’d lay off the gambling for a while. It looks to me like a sure bet that you’re going to need every penny you have just to feed your children.

Back to today: I know the above is not perfect, but it still works for me. I must admit, as I read back, I’m sort of surprised myself how little has changed since then, with all the things that have happened, including of course the new US president. Who now is discussing doing the same thing: buying leftover paperslips from bets lost long ago. And doing so with your money. But that’s not the only thing wrong with this.

Buying $1 trillion worth of toxic assets is nowhere near enough, it doesn’t even begin make a dent in the mess. And if too much of the soiled casino bathroom tissue is left behind in the banks’ vaults, two things inevitably will happen. First, no confidence is restored. None. And second, banks will have to keep hoarding cash to provide for the additional writedowns on the remaining assets, writedowns everybody knows (but doesn’t tell) that are sure to come. The report from the Office of the Comptroller of the currency we discussed last week states that just the three biggest US banks have over $170 trillion “worth” in derivatives positions. Their real assets are stated as just over $5 trillion, and even then we have to look at how real these are.

What lies in the vaults of the remaining 8500 US banks “insured” by the FDIC is an open question. Let’s assume it’s another $170 trillion when all is added up. There are scores of institutional investors, insurance companies, pension funds, hedge funds, mutual funds, etc., that have positions in these wagers. The essential point in all of it, I think, is that the bets have already been lost. That is, the paper is worth close to zero. You’re about to just about literally purchase the emperor’s clothes. As much as people like Tim Geithner, last week before the Senate Finance Committee, and the CEO’s of the banks involved, shout at the top of their lungs that it’s oh-so hard to value the paper, it’s simply not. Just lay it out on the table, and you’ll know.

Thing is, if it were on that table for everyone to see, it would have to be marked to a market value of pennies on the buck, simply because that is the market value. Thing is also that as long as it’s not on the table, it will be politically palatable to to shove additional trillions of dollars that belong to people not yet born, towards institutions whose “leaders” have amassed hundreds of millions for their individual selves, by cashing in on the 1-in-10 bets that won, while offloading the 9-in-10 that lost, onto the public coffer.

Today, your new president and his team are trying hard to find a way to make you believe the races haven’t been run yet. But they have. And that’s why it takes so long to get a bad bank plan together: They need to find the words and reasoning and excuses to make it politically palatable. That is what’s hard, that is what’s making it take so long. It’s not about applying valuations to toilet paper. We all know what that’s worth. It’s about making you believe that the valuation is indeed difficult. Because if you believe that, more of your money, and that of your children, can be stolen from you. Geithner last week talked about computer models putting values on the paper, and about independent (yeah, right!) institutions doing so. Both have failed miserably. All that’s left is a market that will slaughter the entire thing. And that’s not what they want. And that’s what makes it take so long. Nothing has changed since September 29.

Every single day, every single move by our governments dig us into ever deeper holes. Maybe you remember, or at least can imagine, how it was when you were five years old, and tried to cover a lie with another lie, and then another, and all the time you were afraid your mother would see right through you. See? That’s the essence of the emperor’s new clothes, an dof our new-fanged government policies.

Anyway, I’m just trying to tell you, once more, that assets are not necessarily assets, even if your president tries to make you believe that they are, or can be, or might be sometime in the future. So there you have it: if only 15% of the paper slips of only the 3 biggest US banks goes stale and stinky, there is a loss risk of over $25 trillion, roughly twice the annual US GDP. This is not a secret in banking circles. Therefore, $1 trillion will do nothing towards restoring confidence. It’s like the emperor in his new clothes plays hide and seek. And you’re it.

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