Magic Wand Finance

    

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     Now onto today's blog. . . .

        For those of you concerned about my sense of pride -- yes, I sure got that eggy feeling all over my face last week after calling for a thousand-point Dow plunge, only to watch it put on the greatest two-day melt-up in five years. I suppose I underestimate the desperate moves of desperate people against the backdrop of an economy (and a finance sector) that remains unsound to the max despite the 700+ point sucker's rally or dead cat bounce, or whatever you want to call the giddy action in recent days.

     Whatever else you think of it, there is an awful lot at stake in manipulating the collective mood of those who traffic in capital. Beneath the momentary fugue of triumphalism, markets have never been so distressed in the lifetimes of most of us living. It's not just the folks in charge of things whose legitimacy is at stake, but the system itself. When the markets really do start to manifest their true state of extreme disorder, many will blame "capitalism," not the swindlers who have been gaming it in recent years.

     I would pause to remind readers how I regard capitalism in the first place: not as a belief system or a political ideology, but merely as a set of laws describing the behavior of surplus wealth and the "money" that represents it. Compound interest has worked for communists and Republicans alike. The trouble in our case today stems not from the inherent defects of capitalism which, like gravity, exerts its laws no matter how people think or feel, but from cavalier indifference to its laws. One of these is the idea that capital markets will perform credibly -- within reasonable limits of risk -- only if there is agreement that its tradable paper has some value. When markets work properly, fortunes are made and lost on the basis of relatively slight differentials in notions of value. In other words, people must have some idea what they are trading.

     This is referred to as "transparency," meaning that those working the markets can see through the blur of daily action and know, for instance, that IBM common stock is fundamentally valuable (as back in, say, 1969) because every single office in the nation was buying IBM Selectric typewriters and paying for the service contracts that went with them. Nobody doubted that IBM had value, only whether it was worth $57 or $63 a share in a given week, or about how many Selectrics IBM might sell in the next quarter.

     The action in the markets now all hinges on how certain species of "derivative" paper -- certificates based on the value of other certificates -- are valued. The certificates in question are mortgage-backed-securities (MBSs), collateralized debt obligations (CDOs), and other instruments based on debt rather than equity, that is loans rather than wealth. Of course, one problem associated with these things is that they exist now mainly in the forms of electrons in computer systems, represented by pixels on screens, not in paper contracts or promises to pay. Thus they are abstracted not just in derivation but in representation. The further and more crucial problem is not that there is necessarily disagreement over their value, but that, in fact, there's a growing consensus that their value is close to zero. And there is enough of the worthless crap to choke banks all over the world.

      The current distress in the markets derives from the frightening recognition of this problem and perhaps even more from the efforts to conceal it. There was a ton of action on that front last week, which ignited the fools' rally in stocks. For instance, Citicorp, like many other big banks, is choking on scores of billions of dollars denominated in pixels derived from bad loans. Citicorp is in the unhappy position of not being able to cover its losses on this dreck. It appears to have liabilities exceeding its capital assets. It is even having trouble "papering over" these losses -- i.e. borrowing more money to appear solvent. The loan of $7.5 billion it got last week from Abu Dhabi's sovereign investment fund (a nationalized enterprise) came at the cost of 11 percent interest, a rate more commonly associated with New Jersey racketeers than legitimate bankers.

     The event was greeted with triumphal sighs of relief on Wall Street. My guess is this was so only because the managers of money think it will keep appearances pasted together just long enough for them to crawl over the Christmas bonus finish line. It seems to me that there is still plenty of room left for things to go awry.
     Another big spur to last week's engineered rally was the chatter about a distressed mortgage bail-out scheme by Secretary of the Treasury Hank Paulson and others. It would be nice, perhaps, if some honcho-wizard could wave his magic wand and command the adjustable mortgages to magically stand pat for an indefinite period -- say, long enough to sort out the value of all those dubious MBSs and CDOs -- but despite the appearance of good intentions, such a program has no practical viability whatsoever.

     For one thing, nobody really knows where the actual ownership of the individual mortgages has actually landed. This is a major awful consequence of the scheme to disperse risk so widely in the creation of these derivatives. The scheme was so successful that now nobody knows which mortgage belongs to whom and how to begin renegotiating it. So any talk about restructuring these mortgages is absurd, since to do so would require agreement between the borrowers and the lenders. All the lawyers who ever lived would not be able to sort out this mess, and most of the money at stake would end up going to the lawyers now living if the process were to go forward.

     All this is apart, by the way, from the question as to whether insolvent homeowners could keep up with their payments whether the rates were frozen or not, not to mention the further unsettling prospect that the interest deferred would only end up being added to their principal even while the market value of their houses spiraled ever-lower in the ongoing bubble bust.

    A blanket freeze would further degrade the legitimacy of contracts between all borrowers and lenders, making it impossible to price in risk for any future lending contracts -- since they would now be susceptible to arbitrary changes-in-terms by authorities in charge. In the meantime, a court in Ohio has already ruled that one major bank (Deutsche Bank) which thought it held mortgages there, had no legal standing to foreclose on non-performing properties (STORY). Also meanwhile, public investment funds from Florida to Norway are hemorrhaging because of mortgage-associated derivatives clogging their portfolios. Meanwhile, moreover, credit markets have seized up because those supposedly holding capital can't say how much they really have, and are now terrified of loaning out "money" that might actually not be there, not in accounts receivable, not on or off any books, just... not... there... anymore....

     The recognition is growing that our financial markets have been subject to mischief so egregious that there will be hell to pay. The current "distress" is the inability of the markets to function -- no matter what the Dow Jones Industrial Average appears to say at any given moment. The legitimacy of the markets and those now pretending to preside over them hangs in the balance as we slide sickeningly into the holidays.

Comments

[Tangurena]

A copy of the ruling in the Deutsche Bank issue is here: http://reggiemiddleton.typepad.com/reggie_middletons_perpetu/files/deutsche20bank20fc20dimissed.pdf
Effectively, they hadn't bothered to do the paperwork showing that they actually owned the mortgages. I understand that they've since dotted their i-s and crossed their t-s and refiled with all the paperwork done this time.

Sloppy paperwork is part of why this is a mess. As well as opacity: no one really knows what the heck they've bought, nor can they really price it. FASB 157, with the new rules on "mark to make believe" *might* bring a bit of light into this morass of festering rubbish. I'm not betting on it though.

[Rusticus]

Absolutely right on this week, Jim. When I watch the Fed dropping interest rates aggressively in order to stall off the collapse of the financial system, I wonder who these Wall Street geniuses are who think this is a sign of good times to come. Are they really all so dense, or is this just a way for them to get the rubes to jack up prices briefly so they can then bail out of their positions?

[sirbikes]

Interest rates will be lowered again.
Oil is headed back down.
Consumers are still consuming.
The Fed will bail out the looters on Wall St.
Gas is still dirt cheap.
The suburban build-out continues.

[bud4wiser]

"The loan of $7.5 billion it got last week from Abu Dhabi's sovereign investment fund (a nationalized enterprise) came at the cost of 11 percent interest, a rate more commonly associated with New Jersey racketeers than legitimate bankers."

I'm not sure who arrived at the figure - 11% - regarding the money invested by the Oil Kings.

But it should be noted, if true, this means that the Citibank moguls are figuring on another 11% drop in the dollar in the near term.

As far as any Calamity after Christmas -- I doubt it. In fact I'm now resigned to a new slow-motion train wreck [at night] metaphor to describe Peak Oil.

The whole point of the government and finance sector is to generate the greatest wealth for their players as possible through deceit. Hence these arcane monetary devices which can be manipulate wealth away from working classes through inflation, devaluation, taxes and subsidies.

No one yet has figured out how much the Iraq playground has added to the price of a gallon of gas. What's important is the rich and powerful aren't paying for it. They put it on your credit card.

[Uncle Remus]

Note the increased activity around the poop chutes behind the fans...

[Mark]

Anyone see Ben Stein's (no I'm not a big fan) article in the Times yesterday? Did a nice job of calling out Sec'y Paulsen on Goldman's selling CDOs etc. to suckers while at the same time, shorting the same instruments in the market! Nice. Stein then calls into question of whether Mr. Paulsen should even be in his position if he as head of GS was orchestrating such behaivor. Allan Sloan at Fortune has essentially said the same thing.

[artiefacts]

"Whatever else you think of it, there is an awful lot at stake in manipulating the collective mood of those who traffic in capital.

So now you're manipulating our collective mood? You must be exhausted. Keep on prognosticatin' Jim, you're bound to get it right. And all those eggs could come in handy when the oil dries up.

[Success Warrior]

As long as everyone keeps pretendng that the paper is worth something, the game can be played. If too many people stop believing, Tinkerbell will die.

[Andy in San Diego]

Sorry, not directly related to this week's topic, but yesterday I finally saw the effect of the doubling of the price of wheat at the checkout. Bulk flour went from 39 cents a pound to 69. Bam! No messin' around. 75% increase in one pop. Checker was unaware and completely clueless.

[Kickaha]

Kind of silly of JK to be making such detailed predictions for such a complicated beast as the stock market.

Still, he's in good company. Bonddad at http://bonddad.blogspot.com/ offered his own sheepish explanation this morning (and I heard others on the radio).

Bonddad also has a link to some very interesting analysis at Afraid to Trade. Apparently, the major mutual funds are clamoring over each other to put their money in positions of safety rather than growth.

[Holmes, I presume]

As commenter Eureka99 wrote on Sanders’ MSNBC blog (in reference to Chavez’s news conference)…

“This is the Art of saying a lot without telling a thing! Some people call it: "Encher chouriço" (filling the sausage)!”

[FARfetched]

Slow-motion pretty much describes the situation, Bud4wiser.

JHK, you have answered a long-standing question in your first paragraph: many of us have wondered if you ever read the comments here. Anyway, another possible explanation for the current market behavior is an early "Santa Claus rally" - see http://www.investopedia.com/terms/s/santaclauseffect.asp - brought on by the interest rate drop. Up or down, the markets are jittery though. Pointing to 200-point (or even 400-point) single day drops as the beginning of the crash is likely to be futile, because the markets could go up even more a day or two later as people go "bargain hunting."

Meanwhile, in bagholder-land, there are increasing noises about foreclosure moratoriums and rate freezes — even Hillary is getting on that particular train: http://news.yahoo.com/s/nm/20071203/pl_nm/clinton_foreclosures_dc_2 — so it looks like it's going to happen. I actually think this is a way to bail out the paper holders, disguised as a way to bail out home"owners" — first, if the houses aren't being foreclosed, they're not on the market depressing prices even further, which means the asset values stay up, which means the paper looks like it's worth something. Second, foreclosed houses tend to be vandalized or even stripped of useful materials — http://money.cnn.com/2007/11/16/real_estate/suprime_and_crime/index.htm?cnn=yes (I think someone posted this link last week) — so keeping the houses occupied is in the companies' interests at least as much as the dwellers'. Freezing interest rates also helps the paper holders, because it either keeps the residents paying the mortgage (and a performing mortgage is better than the other kind) or keeps rate cuts from cutting into profits.

While a moratorium is in effect, I'd expect the bagholders to figure out who actually owns what so they can actually *be* in a position to negotiate with their debt serfs when the time comes. Like Bud said, train wreck in slo-mo. Keep the game going as long as possible, preferably unto retirement, and then who cares, right? What the hey, if they can unwind it slow enough, even a weak rally might cover up the last of it.

[larsarus]

Isaac Newton got it wrong as well, regarding the "South Sea Bubble" stock market crash in the early 1700s.
"I can calculate the motions of heavenly bodies, but not the madness of people" was his appropriate response to losing 20000GBP when reentering the market after having withdrawn earlier because of his predicton of the crash...

[mistah charley, ph.d.]

Our host writes

To get more specific about the most recent news from the world of finance - about Citicorp and Abu Dhabi - that is not just a "loan" at a high interest rate - it is "mandatory convertible securities" - i.e. ownership, of up to a 4.9% stake - see

http://www.atimes.com/atimes/Global_Economy/IK29Dj01.html

[Jason]

Yikes. JHK - what are you doing linking to a story on a site like fourwinds10.com?? Go read their Mission Statement http://www.fourwinds10.com/siterun_static/general/our_mission.php
Wackos!

[Kickaha]

FARfetched commented on the proposed mortgage rate freeze that I think is correct. This will help the big boys by squeezing a few more pennies from the suckers. As Calculated Risk at http://calculatedrisk.blogspot.com/ puts it, " . . . the purpose of this plan is clear - since the industry lacks the infrastructure to handle the work load, this guideline helps decide which loans to foreclose on now, and which loans to foreclose on later."

[jread]

As long as suckers can be found to pay for paper-shuffling, new types of paper, i.e., derivatives, will be invented.

[PeakLife]

"With World Made By Hand Kunstler makes an imaginative leap into the future, a few decades hence..."

A FEW DECADES HENCE! Even JK acknowledges the sh** won't go down for a "few more decades!" (Snoozzzzzzzzzzzzzze). (But do notice how when dealing with the public, he puts a relative date on his predicitons, though. You people need to get hip to that).

[asoka]

All this macro finance is over my head, but I have two down to earth questions:

1) How can I find out if my mortgage has been sold to someone who has no legal standing? Wouldn't that mean I could stop paying my mortgage, if, as the judge in Ohio says, "They own nothing"?

2) If the Fed lowers interest rates even more, would it be a good time to refinance to at least make lower monthly payments at a lower interest rate?

[PeakLife]

"As far as any Calamity after Christmas -- I doubt it. In fact I'm now resigned to a new slow-motion train wreck [at night] metaphor to describe Peak Oil." -Bud4weiser

Finally, someone with some sense around here!

[eagleye]

I wonder what the banks will do if there is an avalanche of mortgage defaults? At some point it wouldn't make sense for them to foreclose on lots of homes, because of the administrative costs and the fact that there wouldn't necessarily be buyers to take the property off the bank's hands.

Anyway, thanks to JK for the usual dose of Holiday cheer...

[Laura Louzader]

Thank you, Mr. Kunstler, for outlining the strongest argument against a bailout for mortgage holders and investors, which is that it will render contracts worthless and subject to arbitrary actions on the part of authorities.

In other words,a bailout is one more abrogation of contract law and property rights, and one more contribution to the growing lawlessness of this country.

Bad principle, bad effect- this bailout will make life even more difficult for prospective first time buyers, as lenders take steps to reduce their future risks and make credit almost impossibly tight, even for well-qualified borrowers who are borrowing a reasonable multiple of their incomes for a properly-priced property, and have a downpayment. Watch-if this becomes law, lenders will want a minum downpayment of 30%.

In addition to "helping" reckless borrowers at the expense of those of us who spent this rampage sitting on the curb, waiting for a correction in the insane prices, this proposal will not help the only foreclosure victims who really could be said to deserve assistance- people who have lost jobs and/or have pressing medical bills, such as the hapless denizens of cities such as Detroit and Cleveland, where every other house is in foreclosure and vacant, and where it is unlikely there will ever be the jobs to replace those lost in the last flight of manufacturing from these places.

The Dummycrats, and others, supporting this legislation have clearly not taken the temperature of the electorate, or perhaps hold us in profound contempt and prefer to cater to Wall Street investors, for most citizens are vehemently opposed to any sort of bailout for people who borrowed over their heads to buy. Most people would support assisting only those who could prove they were genuinely defrauded, which most of the borrowers now in foreclosure were not.

[PeakLife]

I always knew when the first credit cards came out, that it was the beginning of the end. When you start giving people access to $$$ they don't have, that's it. The beginning of the end. And when it got to the point of "having no credit is worse than having bad credit," that "good credit" is valued over having actual money, I knew we hit a peak. I forecast a return of the "cash is king" mentality in the next 20 years, where "How much you got in the bank?" will become the question, rather than "How's your credit?"

[Dave]

http://tonto.eia.doe.gov/dnav/pet/hist/mcrfpus1M.htm

man, i never knew just how right hubbert was. check out 10/1970. been down hill ever since.

i don't see how we haven't past world peak. this is a good thing of course. we won't have to keep reading stock market predictions for too much longer.

[Dave]

http://tonto.eia.doe.gov/cfapps/STEO_Query/steotables.cfm?periodType=Annual&startYear=2004&startMonth=1&endYear=2008&endMonth=12&tableNumber=9

this page is funny. 37 straight years of declining extraction. but it'll start going back up in 2008.