The Financial "Crises" is Not Over

I have been reading my weekend section of the FT this afternoon and came across two unrelated articles that struck a chord with me with respect to the financial markets. Some items that are notable, 1) Treasuries, since the credit crises, have been the only acceptable collateral in the "repo market" 2) There are still non financial companies out there that are writing off huge losses in derivative "investments" that are way out of proportion to the revenues they had as functioning companies, making me think more non-financial companies than I originally thought got hood-winked by Wall Street into derivative positions way out of line with the regular functioning of their business.

So what does this mean?

First, the huge demand for US Government debt over the last year, despite a normal economic view that any nation running the kinds of reckless borrowing and printing of money the US has been would make rational investors run the other way, is a direct response to the fact that only treasures are being accepted as collateral in the global credit markets and the US Dollar is "reserve currency" by default. Hence, there is a very large demand component to treasuries that is unrealistic, unsustainable, unhealthy and explainable only within the context of the crash of the credit markets. Low US interest rates cannot be sustained much longer without GREAT cost to our financial system, as we know it. The Trillions of dollars in subsidies being offered by the Fed to the credit markets make the billions of dollars of reckless subsidies to say gasoline in Iran or bread in Egypt look like paltry handouts, yet those subsidies are often referred to as dangerous to those countries balance of payments and government debt ratios. Go figure.

Second, after seeing companies like chicken producer Pilgrims Pride go bankrupt largely due to derivative contracts in corn which went bad costing them millions, I realized that real companies that produced real products were pulled into the derivative markets (along with investment funds like Harvard University's Endowment) with promises from Wall Street Firms to "hedge" their operations at levels that were completely out of context with the needs to do so in their every day operations. So when I read that GM, the Bankrupt now Government owned US Automaker, just pumped $413 Million (Won 491 Billion) into it's Korean joint venture with Daewoo, called GM Daewoo, after GM Daewoo had it's "entire equity base (cash) wiped out by Won 2.3 Trillion of currency derivatives losses", I realized this problem has not gone away.

So how do these two seemingly unrelated articles jog my brain? Well, first, I have presumed for some time that the increasingly oligopolistic nature of American business does some things well. They become extremely inefficient and difficult to manage but hugely profitable due to their purchasing power with very large scale orders(evident by the ability of these companies to lay huge amounts of their work force and turn out higher profits with lower revenues); they are entirely responsible for driving manufacturing out of the US with their desire to constantly lower the cost of inputs to meet needs for quarterly profits; they become faceless, unwieldy and largely wrapped up in getting as large as possible by squeezing out any and all competitive elements while colluding with the other oligopoly members on pricing; the collective "tax" these companies call "profits" begin to look like a tax because no longer are these companies benefiting their many individual owners and pools of investors like when there are many players of all sizes in an industry, but these companies start to look like mini socialist governments, taxing their "customers" with fixed prices, lying to, cheating and outright stealing from their customers (at least 1 out of every 3 grocery store visits I make I have to return and get a refund on an item that was overcharged at the register); paying exorbitant salaries to the "apparatchik" (crony insiders) selected to run the organizations; paying their "workers" lower and lower wages and most importantly, generating HUGE amounts of cash which then must be "invested"; the cash generated is so large only Wall Street firms have the wherewithal to handle the money.

This is where Wall Street and Hedge Funds come in. Where does all the cash generated by these oligopoly companies go? It appears much of it found it's way into the same esoteric products that financial and insurance companies were buying and selling which means huge losses on the books of some companies. This is truly where Wall Street hits Main Street and it is only possible when Main Street has become an oligopolistic town with profits large enough to play with the big boys in New York and Off Shore. Now even these huge companies, which have shown a great penchant for halting internal "investment" and "growth plans", cutting dramatically their "inventory levels", laying off huge numbers of employees and hence creating very large cash balances, need to "play it safe" and buy treasuries as there is uncertainty in the economy and lack of any other "instrument" to invest in due to the collapse in the credit markets. The lack of liquidity from “productive industry” (those who make and sell tangible products) in the US is further exasborating the crises and forcing the Fed to offer more support then would otherwise have been needed.

I sense a great deal of resentment building towards the dollar and treasury markets by countries forced to continue to hold both when they know it is no longer economically wise to do so.

I sense companies are going to continue to accumulate cash and hence buy treasuries as a cushion to a potential continued decline in the economy.

I assume there are still huge amounts of esoteric derivative products on the books of many a financial institution (and otherwise) that are basically worthless but being recorded as having value to avoid a collapse in the institutions.

I assume everyone knows these worthless assets are worthless but have stopped pressing for more collateral because there is no more collateral so nobody sees any benefit in continuing to bleed a turnip dry since losses on one party's books simply reverberate into losses in everyone else’s as well.

I figure, there is no near term end to the financial crises because it will take years for all of the worthless paper to be "wound down" so to speak while companies try to "earn" their way out of the financial mess.

What does all this mean? Is somebody going to blink? The markets now only have to drop 100 points for every man in Washington to find a podium and announce a new "program" or "reinforce their support" of the credit markets or "ensure no change in liquidity or interest rates" or whatever to "calm" the markets so they can continue their rise straight out of the stratosphere. It used to take Paulson 300 points to do the same. One needs little more evidence that the smoke screen being sold the public by the media conglomerates and PR spinsters in Washington is a total lie.

The global financial system is still a complete mess. Wall Street is celebrating every time a company "beats" some arbitrary analyst "prediction" of how much earnings and profits would drop over last year. Yes "drop" over last year. So if my profits are only down 18% and revenues down 10% when the street was looking for profits down 20% and revenues down 12% then my stock is going to a 52 week high! Yes I can celebrate that my stock is worth as much as in early 2008 even though my company is doing 30% or so less business than January 2008.

This is all liquidity driven. I love seeing the CNBC pundits all acting like everything is normal again. They talk stocks and earnings like the credit crises never happened. There is no need to discuss the fact that the Fed IS the Residential Mortgage Market, Commercial Mortgage Market, Consumer Credit Market, Student Loan Market, Auto Finance Market not to mention the other myriad of "support systems" in place to keep other markets from crumbling. The interest rates we are all paying on our credit cards, mortgages, and auto loans are all massively subsidized right now by the Fed and FDIC. The rates are COMPLETELY divorced from "market reality" which to an economic minded person like me no longer resembles "reality" at all.

Companies still being brought to their knees by bad derivative bets; trillions of dollars in "assets" on the books of thousands of banks, companies and hedge funds that are in the best case scenario worth $.30 on the dollar; hundreds of billions of dollars in government debt being sold every couple weeks by the Fed to finance the massive stimulus and deficit spending by the government being soaked up by institutions with no where else to turn to put their dollars; commodity prices completely divorced from economic demand realities; stock market valuations 20-40% elevated from fundamental realities, what does this mean?

Simple, we are seeing global inflation of ALL dollar-based assets, which is reflecting as we speak the massive loss in purchasing power of the dollar. Yet the dollar itself is only marginally off against a basket of currencies from last year's dramatic fall then rise again and the Fed is telling us that consumer prices in the US are stable to falling. How much longer can the relative value of the US Dollar maintain stability while the amount of dollars needed to purchase all commodities priced in dollar continues to rise?

If the US economy faces a second dip and other countries economies follow, especially the few developing nations that have held up relatively well during this latest recession, the underlying demand for commodities priced in dollars would drop further putting downward pressure on the price, but will this result in an actual drop in the dollar price of these assets or will the dollar price for commodities simply continue to rise as institutions increasingly seek to get out of their dollars by buying other assets?

This is the big money question. How far will the equity markets rise before someone decides to take his or her cash out in a big way? With all these dollars floating around now and the obvious inflation in the price of every global asset priced in dollars, the absolute dire state of the credit markets has held the Fed's hand in removing liquidity and getting interest rates back to normal levels. Where is the break point?

Removing liquidity will force reckoning by all those firms with worthless assets on their books and could put credit markets back in crises mode. Not removing liquidity is causing the inflation of all dollar-based assets globally. We are paying a huge, unrecognizably destructive price for being both the global reserve currency and the source of the global financial crises. We screwed ourselves and everyone else and there is no turning back. By not allowing the markets to work out the derivative driven credit crises, not matter how immediately painful it would have been, we have simply delayed the inevitable market correction while simultaneously created a new asset bubble fed by to many dollars floating around. The next move will be a double whammy. I cannot wait.

Debt for Profit

I have to say, after reading about CIT and Goldman Sachs over the past few days I have had many occasions to smile. I am forever fascinated by the amount of money made on "debt" in our financial markets. I am also forever fascinated by our government's willingness to allow the credit markets to continue along their corrosive path "creating" new "products" that allow layers of profit to be made or lost all based on some underlying "debt" somewhere.

This quote from Street Insider, has me baffled.

According to reports from the Wall Street Journal, Goldman Sachs (NYSE: GS) is in talks to amend the terms of a $3 billion loan to struggling lender CIT Group (NYSE: CIT).The loan, extended to CIT in June 2008, calls for CIT to pay Goldman $1 billion if it were to file for bankruptcy. Goldman could reduce the total loan amount, though other scenarios likely are being considered. The loan needs to be resolved as part of CIT's move to raise funds as part of its restructuring. Goldman spokesman Michael Duvally said Goldman "is working with CIT and its creditors to enable it to continue to use the facility, which we believe gives it its most attractive cost of funding." Duvally said the potential $1 billion payment is not a windfall payment, but reflects the "present value of the spread to be earned over the life of the facility."

I do not profess any clear understanding of the layers of products that allow "bets" on debt repayment, but to lend a firm $3 billion at a 2.85% interest rate with annual "interest" payments of $85 million as stated in this article on the Dow Jones News Wires ,

The investment bank extended $3 billion in funding to CIT in June 2008, according to regulatory filings. The 20-year contract, which was put in place as the credit markets froze, calls for CIT to pay Goldman 2.85% of the maximum amount lent, which would come to about $85.5 million annually for the first 10 years of the agreement. CIT would be required to pay $1 billion if it were to file for Chapter 11 bankruptcy.

then for Goldman to claim a Billion Dollar payout if the company goes bankrupt is amazing. In addition, Goldman claims to have bought "credit protection" on the original $3 billion which pays again if CIT fails, thus making the $1 billion CIT "penalty" (I would love to read this loan document to understand why CIT would have actually agreed knowing the dire straits they were in mid 2008) plus the credit protection on the original loan which may not cover the entire $3 billion but as long as it covers 70% of the original loan amount, Goldman makes a profit on the demise of CIT.

Wow, lending has become this profitable. Not is lending profitable, but those who buy / sell / trade the multitude of "instruments" linked to the debt have an opportunity to make a mint as well.

It seems like "debt" has become like "oil" in the sense that when a tanker of oil is loaded somewhere in the world it has already been sold forward to someone, options and futures are being traded on the oil and it may actually be "owned" ever so momentarily by many parties before actually being "delivered" to its final purchaser. In addition, there is insurance on the oil, the ship and I am sure a multitude of other products linked to the oil so that the firm moving the oil can also be "protected" in the unlikely event something goes wrong in transportation of the oil. In each of the "transactions" described above, a small "commission" or "cut" of the transaction is taken by someone for providing the "services" or "protection" or "securities" or "contracts" to buy and sell.

Now "debt" is similar. From the fees by those making the loan, processing the loan, brokering the loan etc. there are a myriad of "products" to allow the lender to "protect" themselves from default of the borrower. In fact what stops the borrower from buying protection from themselves in the form of some kind of "insurance" that pays if their business suffers financial hardships and losses ensue, thus causing them to default on the loan? The loan may be syndicated with other loans and sold as a "security", interest payments "stripped" from the loan, bets made on the likelihood of it being paid, the loan itself can be sold to another firm, the loan can be "owned" indirectly through credit protection "products" where someone may have "rights" to the loan or it's interest payments under certain circumstances.

Man, if you can think of it, it has been tried, is being tried or is in the works. This is the "financial industry" and the house of cards built on "debt". The markets for most of these derivative products are not regulated and many of the firms that create, buy and sell them are regulated which puts our entire "regulated" financial system at risk as we have seen over the past 24 months. Yet the game still goes on.

It has been said in some fashion in every religion, "one must not create an economy based on usury". We have done exactly this and are moving ever faster to a baseless debt based economy which will implode; it is a matter of time.

Finally Agree with Geithner on Regulations Needed

I was pleased to read on Bloomberg today that Mr. Geithner has a plan to regulate over-the-counter derivatives. This is so overdue and I have been frustrated for 3 years by various leaders in Washington do anything about this market even though it was largely responsible for the collapse of the global economy.

Not only was it largely responsible for the collapse but very dangerous precedents are being set as I write this where these exotic financial products are being used as a gauge to price debt.

These contracts represent a $684 trillion over-the-counter derivatives market and they are now typically conducted over the phone between banks and customers!

What an absolute trip. I know with the "trillion" word being passed around like water lately another "trillion" figure may not sink in but Think about this number for a moment. What is the US debt, $10 Trillion? We are talking $684 trillion here. Yes, yes many of you will say, "So what." there are trillions of dollars in "derivatives" out there on every other product, commodity, stock etc. traded every day. Yes, "traded" on "open markets" with clear pricing and risks born by those who trade them and these types of "products" are not "insuring" against default of debt.

I was so incensed when I heard a clip by Lloyd Blankfein where he made this point with a straight face. The guy is a raving lunatic in my book to be able to do so. He is a "Hitler" of finance. There is no question. Some may call him a genius but he defends destruction and annihilation of all around him from a financial perspective and as I have said a million times and will continue to say, with 6 billion people on the planet all more interconnected every day, guys like Blankfein and the businesses they run no longer serve any benefit to humanity, on the contrary, they are destructive to humanity, our "capital system" and serve no allegiance to any good on the planet other than to do whatever is necessary to return 30% plus to their investors irrespective to the damage they cause economies and individuals and they operate without rules governed by any sovereign state, territory or jurisdiction (except for the strings now on his firm after taking money from the government and borrowing to feed his machine with the backing of the FDIC).

So some reasoning has entered Washington and they seem to understand the importance of regulating these derivative products. Now what about the unregulated pools of global money driving this, Hedge Funds?