Margin Call

August 13, 2007
     The seas were a mite choppy off Hedge Fund Island last week after all when the Federal Reserve started tossing life preservers of ready cash to the Big Fund Boyz bobbing and thrashing in the swells. Now, about that "money" -- which is, in essence, a bunch of extended lines of credit at the Fed's artificially-low official interest rate -- what actually happens to it? The simple answer is: it disappears into the same ocean of financial woe that the Boyz are drowning in.

     The mere $38 billion that the Fed tossed out Friday afternoon, as the Dow was tanking down a few hundred clicks, will be used by banks and investment houses to cover losses in the synthetic securities they themselves created, and have been trading, during this psychotic final blow off of cheap energy capitalism. In essence, the Fed is buying worthless paper. The trouble is, there is so much more worthless paper out there that all the computers at the Federal Reserve could never generate enough pixelated cash to cover them in the life of this universe or several like it.

     An additional problem: there is a practically inexhaustible supply of "dead" mortgages and corporate loans washing up on the pebbled beaches of Hedge Fund Island. No matter how bad the mortgage-and-credit-derived racket looks now, it is certain to only get worse as the dead mortgages and loans fester in the sun and the tropical foliage on Hedge Fund Island starts to wilt from the toxic fumes of all that decaying matter. This summer is only the beginning of a cycle of adjustable mortgage interest rate re-sets. The numbers go way up in the fall and are scheduled to continue rising well into the winter of 2008. How long do you think the Big Fund Boys can tread water?

     What you're seeing now is a simple matter of financial sector players trying desperately to evade the consequences of their own actions. The fake wealth generated by the synthetic securities they created is now being recognized for what it is: a swindle. The hallucination is over. The collective denial that supported that hallucination is dissolving. The losses are become manifest. Even worse, the losses are growing exponentially because the synthetic securities were used as collateral to leverage far greater multiples of "positions," bets, and plays in a casino-like global electronic trading arena.

      This is what happens when investment gets de-coupled from real productive activity and becomes an end in itself. It has been terrifically enhanced by computer programming. But no amount of digital legerdemain --with the "sugar-on-top" of accounting trickery -- can now hide the fact that there is no "value" there. What's more, the losses are going to have to show up somewhere. If you try to suppress them in one area, they'll pop up in another. If the Federal Reserve tries to cover the losses racked up by the Big Fund Boyz by giving "cash" away, they'll only succeed in destroying the value of the cash itself, i.e. the US dollar.

      Now, few reasonable people can really imagine that the Fed would blunder into hyper-inflation. But the situation is so desperate that the Fed's mission to do what's necessary to rescue drowning banks may over-ride the prudent deployment of cash life preservers. As that occurs, foreign holders of the US Dollar may detect the impending loss of value of the dollar, and there would be a stampede to the redemption windows to get rid of them. That would leave the Federal Reserve (and by extension the American Nation) in a position of stark and implacable insolvency.

     In any case, the US now stands on the brink of an unprecedented liquidation of assets. The mortgaged title holders to over-priced McHouses will have to liquidate their positions as "home-owners." The over-leveraged holders of credit-card debt will have to sell their Ford Explorers, bass boats, sports memorabilia (good luck with that shit) and flat-screen TVs. The retired dentists will have to dump their stocks and bonds. The corporations will have to sell off subsidiary operations, buildings, and corporate jets. Some colleges will just shutter. The Big Fund Boys will have nothing of value left in their portfolios to sell. They will just drown. Their heirs and assigns will then have to dispose of the house in Sagaponak, the 10-room apartment on Central Park West, and the family fleet of SUVs. The Big Boyz will take quite a few institutions with them -- the club-like banks and investment "houses" that employed them and went along with their mendacious shenanigans.

     The upshot is that we are going to find ourselves a poorer nation. There will be far fewer people with money. There will be far fewer buyers of repossessed McHouses, bass boats, etc. Even the houses in Sagaponak and the Manhattan apartments will go cheap. The effort to pretend our way out of a financial crisis will fail. Sooner or later the recognition will set in that all that "boo-yah" was dreamed up. The United States swindled itself. We became a nation of such greed-crazed clowns that we committed financial suicide in an orgy of self-deception.

     Anyway, that's how I see it this morning. The equity markets open in a half hour or so. The mood out there must be dark. The hands that hold the Starbucks cups must be trembling at the trading desks. I hasten to add that I think the turmoil and destruction can go on for quite a while. This slow-motion train wreck is not going to play out in just a week or two. And in case anyone forgets, in the background looms another storm at least as potent as the one now blowing through the financial markets: the gathering permanent global energy crisis (a.k.a. "peak oil"). Just because some Big Fund Boyz liquidated their positions on the oil futures market last week to try to cover their losses elsewhere does not mean that price of oil is going to keep going down. It may rest on the ledge in the $60 -$70 range for a spell, but you can be sure it will take flight again. And if it does as the dollar is crashing for other reasons, this will become a pretty disorderly nation in a very dangerous and unforgiving world.

Comments

[Rabid_aGnostic]

There is also a bigger problem inherent in this economic free-for-all: as we "contract" economically, there is a so-called election cycle under way. The poor bastard (or bastardess) that "wins" the presidency will inherit a shit-storm; look for a divided house in our entire outlook (e.g. rich vs. poor, Reps vs. Dems, etc.) that will further the fall.

[asoka]

Great this week, Jim!

Metaphoric madness!

[Uncle Yarra]

RabidA,
You're right, we're first in Oz with our election due in several weeks. We've just had our 6th(?) interest rate hike in a row. The blame game in the media is as divorced from reality as the US situation. I would definitely NOT want to be a politician in ANY government in the next few years.

[The Dancing Cavalier]

So what DOES the average Joe do? Someone with a conventional mortgage, under 15,000 in consumer debt (car, education loans, the like)? How do you go along for the ride without being ridden?

[Laura Louzader]

Great post, except that this reality has not yet sunk in among many players, let alone the public.

It is felt that the activity will shift elsewhere, and maybe some large money will. Many more sensible, reality -oriented players have been sitting on the sidelines since 2003, which is about the time that things began to get pretty bubbly in the housing market.

The public, particularly those who have bought houses or condos, are in denial. The developers are in deeper denial. New midrise condos are going up in my neck of the woods while hundreds of units languish on the market for as long as 600 days. Others are ending up on the auction block, and one major developer here in Chicago is being foreclosed on the $14 Million construction loan (which he guaranteed personally)for his failed mixed use project on the banks of the Chicago River. However, none of this is enough to deflect developers who are planning MORE CONDOS in my neighborhood.

The blood bath will be very deep. Many people who manage to hang onto their overpriced dwellings hung on through the first reset but they won't survive the second. Credit is becoming much tighter, and many lenders will, in the most overpriced metro areas, demand 20% down just to cover depreciation risk. Appraisals are are getting much stricter.

Money will be extremely tight for the next few years.

Now that people can finally find a nice dwelling for a price reasonably related to the rent it fetches and to the buyer's income, will they still be employed?

For I expect massive shrinkage in the financial industry. There always have been about five times as many people in the various subsets of the financial industry as were really justified. Expect more really huge layoffs.

[TroutBum]

Jim,
The $38 billion you described was actually a REPO, a short term loan which will be paid back today in Cash w/interest.For a good explanation see:
http://www.hussmanfunds.com/wmc/wmc070813.htm

Of course, you're correct about the mortgage, the CLO, and CDO problems, especially since the Hedgies are up to their levered eyeballs with this stuff. That's the story, the market for these securities simply closed down, the only buyers were bottom fishers offering .05 to 10 cents on the dollar. There is much trouble ahead in these markets.

[Rabid_aGnostic]

Good call, Laura. I have two neighbors who decided at the beginning of this year, because of layoffs at their jobs, to start a landscaping business. Like the good guy I am, I warned them of the impending bubble deflation; they did not listen nor hear me. I was just being a Cassandra.

I saw one of them last week. He's a stocker at the local HFCS emporium (aka: supermarket) at night. I asked him how his landscaping gig was going: he didn't say much except to say "Well, I'm working here, aren't I?"

It will eventually sink in with the public; the constant shifting of "money" will only prolong the agony. Let the system fail soon, so we can get through deceiving ourselves (collectively) and rebuild something worth a sh*t.

[bud4wiser]

JK, me thinks you protest too much.

While I ascribe to your concerns that Hedge-Fund-Island inhabitants may indeed have no need for sunscreen this summer, you seem to have forgotten just how creative the financial-meteorologists at the Federal Reserve can be. This storm is of no real concern.

Levees never break exactly when and where you are looking. Yet the sub-prime-debacle is as you say a mass of "festering tropical foliage" that is obscuring the weakest points of this nation's dam of fantasy-backed, fake-credit.

Who would have thunk it? A government props up a 9.5 trillion dollar deficit and expedites corporate/financial pirates rifling through the economy, and the next thing you know - CLUSTERFUCK!

There is skulduggery a foot, but in this Clusterfuck, it's hard to say whether the oceans are rising or the Island is sinking.

God Save King George, good day to all.

[PeakOilBoy]

Luckily, the country can survive on Bean Burritos while we build small-scale alcohol fuel plants at the co-op level.

Warm your body, not your cave, right?

Here's one for you.... how does the SP, the SCO, and the Amero play into all of this?

2nd bonus question: Does anyone know the dates that operation Noble Resolve go live in Portland? Nothing like a live Nuke exercise to get the citizenry's underwear all tied in knots.

[Matt Savinar]

Peak Oil Boy,

The bad news is Portland is primary target.

That good news is Portland is a primary target. This means it will be over quick.

http://www.ki4u.com/nuclearsurvival/states/or.htm

[PeakOilBoy]

Well, I'm not gonna leave town... Noble Resolve is supposed to go live any time between Aug. 20 - 24th (according to someone who claims to know something about the operation).

If Portland gets wiped out, I did my best!

As Yoda says... "Forever Sleep". But my hope is that our fair city gets to play the game longer and we aren't the first kid to get hit with the dodgeball.

[craig]

As always an insightful post. On thing I wonder about: On the one hand the dollar will devalue (inflation). On the other hand houses and SUVs will devalue (deflation). So which will it be, inflation or deflation? Or will it be that houses and cars will be cheap but there will be no oil to heat and driver them. We will all be starving in McMansions. Any answers?

[waitingforthealiens]

Your are wrong about one thing: they'll never sell the corporate jets.

[msjanket]

I'm trying to find loopholes in the PO Armageddon for a little breathing room...but I can't. My incipient funk is testament to the fact I feel trapped in the limited future we all face. Jeez, I'm a dentist and Jim tells me that my stocks and bonds will be worth what Deutsche marks were worth after WW2. And, I don't have many wheelbarrows filled with greenbacks to start, either.
My retirement will be pushed back to one day after my demise...happy thoughts to occupy my time with...
Why am I blue? It's because I will lose all my green.
Been nice while it lasted. Pass the flexible pipe that fits over my muffler,

[PeakOilBoy]

Here's a question: Should a person that still has access to credit buy land now, or wait a while?

Will farmland go up or down?

[Tangurena]

The construction companies are popping up houses still, because that's the only way they can get ~any~ money back from their "investment" in land.

[David Mathews]

Hello Everyone,

For those who don't appreciate the sheer insanity of economists, listen to this man:

http://mises.org/multimedia/mp3/MU2007/23-Reisman.mp3

"Environmental and Resource Economics" George Reisman

If that isn't enough economist-insanity for one day, you can find plenty more here:

http://www.mises.org/

The supply of human stupidity is inexhaustible. Too bad that the supply of humans is not inexhaustible.

[Lurkerlu]

PeakOilBoy - I'm going to stay too, although I'll be spending the week converting my basement into a fallout shelter. I'm about 8 miles SE as the crow flies from ground zero (at least according to the Harvard "study"), so who knows. I was gonna get out but a big part of me wonders if it would be better to not be around - anywhere - for the aftermath if the lizardpeople actually do this. I was struck how that study is mostly concerned about who's going to be in power in the aftermath - not how to actually help survivors. Fucking heartless bastards.

Even though it's hard to get too worked up about doom in financial markets when staring down the nuclear barrel, I have a stupid question - if resetting the mortgage interest rates will cause widespread foreclosure and other economic catastrophe, why not just not reset? I assume there is a choice here.

[Riddick]

Hey PeakOilBoy, land is always a good investment, especially in an ever crowded world. However, prime farmland with good soils will be worth pure gold one day if only due to the ethanol hype. With all the impending storm clouds this site mentions prime land will be needed soon to attempt to keep everyone fed. All the land lost to tract housing, freeways, malls, strip centers, amusement parks, big box stores and golf courses may become more valuable bulldozed, plowed and replanted in the not too distant future.

[Riddick]

Hey PeakOilBoy, land is always a good investment, especially in an ever crowded world. However, prime farmland with good soils will be worth pure gold one day if only due to the ethanol hype. With all the impending storm clouds this site mentions prime land will be needed soon to attempt to keep everyone fed. All the land lost to tract housing, freeways, malls, strip centers, amusement parks, bib box stores and golf courses may become more valuable bulldozed, plowed and replanted in the not too distant future.

[Kati]

Also wondering what us average working folks should do to ride out the storm. My hubby & I have no investment funds, though our daughter does have some bonds the grands have bought for her for birthdays & such. Should we withdraw some cash to keep on hand??? What is your suggestion for those who have decent, mostly-necessary jobs, a home bought BEFORE the bubble on comfortable (though certainly not TOO comfortable) means, owing less than $20,000 in debt (not including morgage)..... *shrug* Give us average folks some ideas, please!!!!

[DaveL]

This guy has some good ideas.

http://www.penttilinkola.com/pentti_linkola/ecofascism/

DaveL

[politickybitch]

Riddick,

You might want to take into account when you discuss the future of farmland the (rapidly being depleted) Oglalla aquifer.

Kansas Farmers Learn from Past as Aquifer Depletes

http://www.npr.org/templates/story/story.php?storyId=12595774

[Holmes, I presume]

Trajectory for America?

The Death Throes of the Hegemonic Wildebeest Phase (stewarded by Giuliani or Clinton to an ignominious end -- the twitching and flailing could go on for quite awhile, as well as military escapades, financial shenanigans, etc.)

The Substantially Powered-Down Post-Collapse Phase (relatively short and chaotic transitional period when Libertarian ideas are championed by well-meaning but generally clueless politicians such as Ron Paul.)

The Fascist New America Phase (after various waves of hell leave behind their wreckage, ideas such as those of Pentti Linkola -- see DaveL’s link above -- start making a lot more sense to those who are still around, particularly Alpha Thugs in the process of consolidating power.)

[Nudge]

A question for the economics heads here:

What portion of America's wealth (real or hallucinated) is made up of residential real estate? If that stuff is considered an asset, then we're already seeing rapid asset deflation in that sector.

When does this begin to translate to currency deflation?

Seatbelts on.