Shoes Dropping

      The fall of Britain's Northern Rock bank may be the first dropped shoe in a chorus line of big banks tap-dancing into oblivion. The British government's move yesterday to nationalize the insolvent mortgage lender's remaining operations leaves shareholders holding an empty bag. Their only resort now will be to call their lawyers. What we may be witnessing, in a movement that will surely spread to the US, is a changing of the guard at the top of the financial food-chain between bankers and lawyers.
      Shoes may have begun to drop in the US last week with Citigroup halting redemptions for its $500-million CSO mini hedge fund -- half a billion dollars being something less than walking-around-money in the Hamptons these days. Halting redemptions means that investors in the fund cannot withdraw their money -- the same as going to the bank and being told your account is frozen. Hedge funds can play rough with their investors because they are unregulated. The reason they remain unregulated is the presumption that anybody rich enough to "play" in a hedge fund can afford to lose (or be swindled) with no protection on the sidelines from government busybodies. What's more, the hedge fund managers do not have to make any of their operations open to public view, so that neither the investors nor any regulating authority knows what they are actually doing.
     What the big banks who run many hedge funds are doing is going broke. They are pretending to be solvent by borrowing money from the Federal Reserve, the nation's alleged superbank. But borrowed money is not capital, i.e. surplus wealth wholly owned. Borrowed money is an obligation, a liability, a negative on the balance sheet. You can't have an entire financial system based on nothing more than a giant daisy-chain of liabilities. Somewhere there has to be a "reserve" of assets, items of value owned by somebody.
      Through most of modern times, assets have been denoted by cash money. A given bank will hold in "reserve" say $10 billion in money that is not owed to anybody, allowing them to do things like pay depositors who show up at the window needing money for groceries. Up until a few decades ago, nations held an ultimate reserve of actual gold in a vault (Fort Knox, Kentucky, in the case of the USA) and the physical possession of this gold was said to "back up" the value of the certificates that circulated as a "medium-of-exchange" or currency.
      But that system was considered too awkward and "reserves" were then denoted in just currencies themselves, or certificates that represented the existence of currencies held elsewhere, or pixels on a screen representing the movement of alleged piles of currency from one place to another, or the intention to move a notional pile of currency to a theoretical destination, and then that became an algorithm purporting to represent the future arrival of a notional pile of money at theoretical destination to-be-named-later, and so on.... And after another while, the nature of money became so detached from anything real, so abstract, that its very existence became hypothetical. Even this "worked" for a while, in terms of the managers of this money being able to "cream" substantial amounts of this hypothetical money off the top of their notional operations and translate that hypothetical cream into Tribeca lofts, Gulfstream jets, and other real luxuries.
     The rest of the economic food chain -- and the social order that represented it -- got stripped of remaining asset value (and social value) until they had nothing left to trade with except debt, in one form or another, and this phase of the game turned out to have a short lifetime when the the only debts remaining to be monetized were the contracts on houses occupied by people with no hope of ever meeting their obligations -- and then the whole sorry racket started to go up in a vapor.
     This is roughly where we are, and where the banks stand today. They are pretending to have money and desperately cadging loans from all comers to keep appearances up, but the loans can't come in fast enough. The appearance of confidence is crucial (as it is, of course, in any "con" game) to keep the investors (depositors) at bay. If a bunch of investors (depositors) all got nervous about the solvency of a given bank, they might try to slip in there during business hours and withdraw or redeem their "money" and perhaps translate it into items of value like gold coins, bottles of vodka, or cases of 9 millimeter pistol ammunition. And if enough of this bunch showed up at the same time, we would see a phenomenon called a "run" on a bank. And after that started at one bank, the thing Franklin Roosevelt called "fear itself" could easily spread to depositors in other banks pretending to be okay... and that would be the magic moment that the USA discovered it was no longer a rich nation.
     That would be a very rude awakening. The whole world would know about it in about thirty seconds, and the rest of the world would be in a lot of trouble, too, since so much of its notional wealth is represented by piles of US dollars (or certificates denoting them). Then what you could see is a run by other nations (investor-depositors) on the United States of America as a whole, or an awkward global receivership process, in which all remaining assets were stripped -- including maybe even some of those Tribeca lofts and Gulfstream jets.
     Of course, the rest of the world would have a hard time getting any of this stuff out, or fencing it off at a discount. Rather, they'd probably just eat their losses and quarantine themselves off from the world's new financial-and-economic leper. They'd stop sending us Toyota Highlanders, plastic salad shooters, and, oh yes, oil. We'd be left with a lot of empty big box stores, vacant highways, and houses inconveniently deployed too far from any place of utility. One thing we'd have plenty of, though, is home-grown pissed-off people. Some of them may even be lawyers.

 

Note: my novel about America's post-oil future, World Made By Hand, is now shipping to booksellers everywhere.  Get one. You'll like it.

Comments

[EEofDC]

Good call on the book plug, Rico.

JHK is startin' to run out of gazz, IMO.... but, no matter, that's not why we come here. Am I right, boyz and girlz?

And thanks, OGH, for the Mike Whitney article on Bernanke's sermon to our public servants over on the east side of my current hometown. The comments section is worth the price of admission e.g.:
Problem-solving is a 3-step process: 1) define the problem; 2) define the solution; 3) implement the solution. Now let us apply this to the coming economic crash.

The problem is simple to define:

You have a money supply saturated with private bank notes that have extracted all its wealth via compounding interest. How it is done? First bank loans are systematically made by banks that replace genuine currency with bank loan debt. Once the money supply becomes all debt the banks have fulfilled their chartered purpose. If all of the money supply is esentially one giant bank loan, where does the money come from to pay it back? Collapse is inevitable. To delay this inevitable, ever increasing bank loans are issued so the older loans can be paid off. It does not change the inevitable collapse, but keeps people busy- and in servitude. This issuing of bank loans is the main cause of inflation, inflating of the money supply. Once compounding interest rises on its logarithmic curve, inflation starts accelerating to match the increasing bank loans circulating in the money supply. At some point the banks will limit the amount of bank loans, probably because inflation will become obvious. This will cause defaults. At some point defaults will start catching up with new bank loans. This is stagflation. We are at this stage in the cycle today. Once defaults surpass new bank loans, deflation occurs and the money supply starts contracting. This contraction will accelerate as banks write off bad debt. This is because most debt is on the computers of the banks, so pressing a key will effectively remove the virtual notes from circulation instantly. This inflation-stagflation-deflation bell curve is the "business cycle". Everybody gets screwed but the bankers. The bankers claim bankruptcy, do not pay back the wealth they stole, then go on to create a new bank and repeat the "cycle".

The solution is just as simple:

The government can put a freeze on all bank debt. This will stop the business cycle. The government can then force the banks and its owners to make good on all federal reserve notes in circulation. This will liquidate the wealthy class as they do not have enough assets. The amount that the wealthy class defaults on, the government can swap out with its own interest-free notes. No one loses except the bankers, a complete flip of the tables. The federal reserve can be disbanded, fractional banking can be outlawed, and those part of the federal reserve system prosecuted for accessory to conspiracy and organized crime. The governement would continue to print its own interests-free notes that will remain in permanent circulation in the money supply, The government would ensure, through mathematics and statistics, to keep enough money in the money supply to maintian monetary stablity.

Implementation of the solution is easier yet.

The US Treasury owns and controls the printing presses that the federal reserve banks rent to print their bank notes and coins. Within one month, the government could get up to speed printing its own money. It could simply alter the current federal reserve note design to say "United States Note" instead of "Federal Reserve Note". Within several months federal reserve notes could mostly be replaced by genuine currency. It is an emergency action to prevent bankruptcy of the state. The government has the consitutional power to freeze the loans of the banks and to confiscate the assets of their owners, even if military special forces have to be dispatched globally for a "Sadam-hunt". The wealthy class can run, but they cannot hide.

Problem solved! This may seem abstract to first time readers only because you have never been taught this stuff in school. Like the 5 year old child, you are learning for the first time, and you have lots of questions.....
Solution101 | 02.16.08 - 4:32 pm | #

[Holmes, I presume]

The British have a long history of nationalizing industries. Historically, they have been far more active in this regard than the U.S. government.

I’m not so sure that what is happening with Northern Rock is the way that it will play out here. I would expect a more convoluted arrangement to unfold on this side of the pond. Lawyers will necessarily be involved (at a minimum, on behalf of shareholders) when banks are swirling down the toilet, regardless of whether there are attempts at nationalization.

With regard to the likelihood of U.S. bank nationalizations happening, it might be just as relevant to talk about what happened in Australia in 1948 or in India in 1969.

Feel free to put down the lubricant, Mr. Savinar, and weigh in on this week’s topic... go ahead... don't be shy.

[montysano]

"What exactly is Matt Savinar adding to the discussion - besides an obsession with ass-fucking?"

Nothing. Neither of you are adding a thing.

"You or Matt can chime in anytime when you want to actually discuss banks. Don't let me stop you."

Actually, I did. But I'm sure it got lost in the grade school flame war that followed.

@ EEofDC: interesting post, but to call your solution "simple".... not so much. Yes, it would be great if the world turned upside down, and the bankers and the wealthy were forced to take responsibility for their financial adventures. However: it will never happen. You and I will continue to foot the bill.

@ Nudge: I admire your call for personal financial responsibility, but again: it ain't gonna happen. That's why we had banking regulation back in the day: to prevent stupid people from doing foolish things. When banks empower, and encourage, stupid people to do foolish things, they're not doing their job. Am I an advocate of vigorous govt. regulation? Damn skippy I am. People will not do the right/smart thing. Corporations will not do the right/smart thing. They have to be forced.

[montysano]

"What exactly is Matt Savinar adding to the discussion - besides an obsession with ass-fucking?"

Nothing. Neither of you are adding a thing.

"You or Matt can chime in anytime when you want to actually discuss banks. Don't let me stop you."

Actually, I did. But I'm sure it got lost in the grade school flame war that followed.

@ EEofDC: interesting post, but to call your solution "simple".... not so much. Yes, it would be great if the world turned upside down, and the bankers and the wealthy were forced to take responsibility for their financial adventures. However: it will never happen. You and I will continue to foot the bill.

@ Nudge: I admire your call for personal financial responsibility, but again: it ain't gonna happen. That's why we had banking regulation back in the day: to prevent stupid people from doing foolish things. When banks empower, and encourage, stupid people to do foolish things, they're not doing their job. Am I an advocate of vigorous govt. regulation? Damn skippy I am. People will not do the right/smart thing. Corporations will not do the right/smart thing. They have to be forced.

[longtimelurker]

"People will not do the right/smart thing. Corporations will not do the right/smart thing. They have to be forced."

~montysanto

Forced by whom? Governments? They've also been consistently proven to be unable to do the right/smart thing...

[longtimelurker]

"The salvation of our society, if such is to happen, will only be by the action of them who know how to manage their own finances properly ~ which seems to be a vanishingly small portion of the population at this time."

~Nudge

So small, in fact, as to be unable to act as any sort of salvation whatsoever. It's too late this go 'round. I fear we're in for some ugly times ahead. Forget the 70's - they were a "cakewalk." Think the Great Depression - on steroids.

[Nudge]

Montysanto, once upon a time in the UPL (that's United Parking Lot of America for you n00b's) there was this venerated institution called the poor house. The folks living there were required to toil in the fields, making produce, until such a time as they had earned the right to leave the place and return to normal responsibilities. I wouldn't give a rat's ass at this point if half the population were consigned to living in poor houses.

Pumping up the level of regulations is in itself a self-defeating game. Witness the sort of pap that passes for public debate here in the UPL when bad things happen. Immediately all the right- and good-thinking people (who we can safely label the do-gooder team) assemble to discuss how this could have been prevented. Sometimes that mode of thinking comes up with very strange results. For instance, part of what came out of the 9/11 event (in the form of Bushco's so-called Patriot Acts I & II) was a move to spy on everyone's reading habits, all the way from their library usage to whatever books they might buy, all under the flimsy assumption that the 9/11 event might have been stopped had we known that said Saudi terrorists were studying how to fly jetliners. This mode of thinking relies on the untrue proposition that all bad things are foreseeable and preventable, and that achieving that level of situational control fully justifies the means needed to implement it.

All we need now are a few more school shootings, and the firearm foes here in the UPL will have plenty of ammo for their own little war against legal gun ownership.

People and businesses alike should have enough latitude to make their own bad decisions and then get stuck living with the consequences of the same.

[longtimelurker]

^ And now we have the answer as to why Nudge is waiting for WMBH to arrive at her local "brick and mortar" (sorry 'bout that term, Nudge) - to make the purchase in cash. I don't blame you one bit.

Make sure to wear a disguise, so as to avoid giving away your identity on the security cams in the store. You could always pay some kid to go in and buy it for ya, too. :^)

[EEofDC]

"...but to call your solution "simple".... not so much."--montysano

Actually, if you had read the whole post, you might have noticed that it was not MY solution, but an interesting comment from an article linked by OGH, one of the regulars here at CFN.

The tectonic plates are shifting and anything is possible, monty. Never say never!

"`Well, be off, then!' said the Pigeon in a sulky tone, as it settled down again into its nest. Alice crouched down among the trees as well as she could, for her neck kept getting entangled among the branches, and every now and then she had to stop and untwist it. After a while she remembered that she still held the pieces of mushroom in her hands, and she set to work very carefully, nibbling first at one and then at the other, and growing sometimes taller and sometimes shorter, until she had succeeded in bringing herself down to her usual height."

http://www.cs.cmu.edu/~rgs/alice-table.html

[Nudge]

LTL, I'm very much afraid that you're right about the nature and scale of the coming financial tsunami. The Lesser Depression of the 1930s will prove to have been a cakewalk because it was a money crisis against the backdrop of an abundance of physical resources, a fine-grained network of still-functioning local & regional economies, a nation that was not dependent on huge inflows of energy and other materials just to maintain its most basic standard of living.

No, what we've got here will most likely be a money crisis against the background of a society that's unsustainable on almost every level without vast inflows of supporting energy & materials which it will soon longer be able to afford.

LTL, actually I'll be using a gift card that a coworker got me at Christmastime. Parking around the corner from the bookshop doesn't do too much good as I'm possible one of the least inconspicuous people in this part of the land, oh well. Most of the time, though, I tend to use cash for purchases anyway just as a matter of choice. Amusingly, the bookstore said there were almost a dozen copies of the book on order, which made me wonder which of the other locals are onto this stuff.

[LaughingAsRomeWasBurningDown]

So many flames, so few marshmallows:

http://www.cnn.com/2008/US/02/18/refinery.blast/index.html

An explosion rocked a Texas oil refinery Monday morning, shaking homes three miles away, witnesses told CNN.

Video from I-Reporters showed a massive cloud of smoke forming over the refinery in Big Spring, Texas, about midway between Dallas and El Paso.

The refinery employs about 170 people and can process about 70,000 barrels of crude oil a day, according to the Alon USA Web site.

It supplies an area including West Texas, New Mexico, Arizona, southern Oklahoma and Arkansas with fuel products and asphalt, the Web site says.

CNN affiliate KOSA-TV reported that Interstate 20, which passes the refinery, had been shut down.

[stoic]

Called Borders and they told me that I couldn't buy it until the 28 when it was to be shelved. Amazon, on the other hand, will ship it tomorrow. I also ordered the "Transforming Energy" DVD. I look forward to a good read. Thanks Jim.

[montysano]

@ longtimelurker:

"Forced by whom? Governments? They've also been consistently proven to be unable to do the right/smart thing..."

I disagree. Before the deregulation fad, they did a reasonable job of limiting what banks could and could not do. There were no 100% mortgages pre-1980; there were no interest-only mortgages; I couldn't easily use home equity loans to suck all the equity from my home.

Derivatives, as we know them today, didn't exist. In fact, derivatives were created to exploit a loophole in the few remaining regulations.

When people say "the govt does a lousy job of _____", my solution is to fix it and make them do a better job. Getting govt out of the way, so that we can experience the "magic of the markets" is what got us to the sorry state we're in.

@ nudge:

Your statement that "I wouldn't give a rat's ass at this point if half the population were consigned to living in poor houses." makes it hard to take your argument seriously.

[longtimelurker]

"Parking around the corner from the bookshop doesn't do too much good as I'm possible one of the least inconspicuous people in this part of the land..."

Nudge, if I've told you once, I've told you a thousand times - you have to stop walking around town with that bow and quiver slung over your shoulder! It freaks the locals out...

[LaughingAsRomeWasBurningDown]

If you're driving a Honda Insight, then you don't need to worry about getting in some government database for buying one of JHK's books; you're probably already in there for sure. Don't real Americans drive Hummer H2's or at the very least, if you must be all green and eco-feely, then a Yukon Hybrid?

http://www.gmc.com/yukonhybrid/index.jsp

I'm being sarcastic on that last part. I'm actually dreading the day I lose my Hybrid/HOV parking spot to one of GM's hybrid drivers.

[longtimelurker]

I don't completely disagree with you, montysanto. Just pointing out the fact that government is pretty much as apt to make poor decisions as any individual/corporation. The fact that the government decided to deregulate, is, in and of itself, proof of this.

Good point, LARWBD.

[Nudge]

LTL, perhaps if I sewed some kind of bag into which the riser and limbs of the bow can fit? Oh well, at least the police haven't been clueful enough to count the arrows in the quiver, else they'd ticket me for having a large-capacity magazine. It's weird, but lots of people don't recognize the recurve bow as belonging to a certain class of weapon. It's more accurate than a musket/shotgun and reloads faster than a break-open model.

Laughing, no offense taken. Ironically the potential tax credit vanished the year I got my Insight, because our dear politicians reworded it to favor those who purchased flex-fuel Hummers (which still get horrible mileage) on a loophole caused in part by the way the EPA calculates the “gasoline mpg equivalent” of ethanol (gasahol). I'd still rather keep the 75mpg car than be driving anything from GM. Oh, and did I say it's aluminum and doesn't rust?

Laughing, which vehicle of yours are you referring to?

[LaughingAsRomeWasBurningDown]

a Prius. Had a CRX before that, considered an Insight a few years ago, but wanted something with 4 doors.

[DanB]

Hi all, I'm just a lurker but I have to say that I've learned a lot from both the blog and the comments. You're right about living within your means, it's the only way to go. However we're all in the same pot of soup when it begins to boil, I do get a kick out of the economists and their blather. When reading most of them, I get a mental image of some guy squatting nakedly in a hut reading chicken guts. Just me, I guess. Anyway keep it up you guys, I'm learning a lot.

[Nudge]

LARB, holy cow, thanks for the Yukon Hybrid link. What a hoot! On the ICE side it's got a 6-litre flex-fuel displacement-on-demand V8 capable of generating 332HP @ 5100rpm, and on the electric side it's got twin 60KW motors. Most of the time, this vehicle will probably be hauling just one (1) human.

The fuel-savings comparisons given on that page are for the conventional 2WD Yukon (14 city, 20 highway) at MSRP $36,245 vs the hybrid 2WD Yukon (anticipated 21 city / 22 highway) at MSRP $50,945.

Oooooh, let's play with the numbers, shall we? The opportunity cost difference is $14,700 for 7mpg difference in city driving and 2mpg difference in highway driving. Just for kicks we'll go along with GM's EPA estimates, even though they're way off base in real life.

For the all-city-driving scenario, let's see .. if the fuel cost averages $4.00/gallon over the usable lifetime of the vehicle, the fuel cost difference is $953 per 10,000 city miles driven, meaning that it would take approx 154,000 miles of city driving to recoup on the hybrid cost difference. If fuel averages $3.50/gallon during this time span, the fuel cost differential is $833 per 10,000 city miles driven, meaning that it would take approx 176,000 miles of city driving to break even on the hybrid cost difference.

For the highway driving scenario (tee hee) .. if fuel averages $4.00/gallon, the fuel cost difference is $182 per 10K highway miles, meaning that it would take approx 807,000 miles of highway driving to break even on the extra cost of the hybrid. At $3.50/gallon it's 918,000 miles required to break even.

The break-even mileage is in most cases far beyond the anticipated actual working lifetime of any American-made passenger vehicle. To summarize, the hybrid Yukon isn't worth buying if your primary goal is to save money via fuel cost savings. You can buy a hell of a lot of gasoline with that $14,700 price tag difference.

To summarize the summary: vote with your money, tell GM how you feel about this sort of stupidity, and go buy yourself a Honda or Toyota.

LARB, congrats on having some kind of hybrid. What climate zone do you live in? Just curious. Wintertime afflicts my Insight with sub-60s mpgs, and warm weather puts it up above 70. My best two long-distance mileages were 78.7mpg from Boston to Schenectady and back, and 75.4 for Boston to Ohio and back.

[Johnny Rico]

I had a lot of problems with the content of Jim's piece(what else is new?) - but we can probably save most of them indefinitely since one of two things is going to happen.

1) These issues - banks, credit, hedge-funds, economy, housing, etc. will turn out not to be armageddon, but just another downturn in American history* - in which case my disagreements with him will be self-evident.

2) These issues will continue to be front-page news for 6 months or a year, in which case Jim will be writing the same 1000 words on many more Mondays, just rearranging the letters in ever more elegant combinations. And I'll have plenty of time to respond.

But it looks like today the focus os CFNunderground is "fiat money" vs. "commodity money" as the root of all evil.

If so, before we move on, I think it would be good if everybody was on the same page.

This is a decent(and short) wiki on The Gold Standard.

http://en.wikipedia.org/wiki/Gold_standard

It shows immediatedly some of the erroneus assumptions and technical slips Jim made, but it also (surprisingly?) quotes Alan Greespan in agreement with Jim.

Also, and this probably pertains most to what Montysanto said, previous to Reagan and the change from the Gold Standard there were financial and crises. The history of those events is crucial.

The Panic of 1907.
The Free Silver Movement.
Bank Runs throughout the 1800s. And I think real-estate related crashes.

Also. The really hardcore implementation of the use of derivatives and financial instruments, SIVs, etc. happened under Clinton. And I found interesting the fact that the Gold Standard was abandoned during WWII.

Here's a quiz before you read the wiki article. Could you answer this now? Did you know that all the gold in the world is only worth $3.65 Trillion - only about the amount of money in circulation in the US.

My question to a previous poster still stands. Can you eat gold? Can you put it in your gas tank?

[PeakOilBoy]

When I was on Portland's Peak Oil Task Force, I often thought what would happen if it went down so fast that the value of money evaporated in a relatively short amount of time.

What incentive will truck drivers have to haul food around?

What incentive will farmers have to run their tractors?

Etc, etc.

[Johnny Rico]

That asterisk was supposed to apply to something I forgot to write. Just make it apply to the sentence 'The Panic of 1907.'

[Johnny Rico]

"What incentive will truck drivers have to haul food around?
What incentive will farmers have to run their tractors?
Etc, etc."

These are good questions. But the answer is basically this: the same incentives they always had.

Meaning: one really doesn't work to make money. Because you can't eat money or put it in your gas tank. You are really working to feed yourself and in the modern age to put gas in your tractor's tank - so (and this is where it really gets weird) you can work, or get to work.

People aren't going to stop working or eating. So the monetary system will adapt in some way to ensure the continuation of these actions.

Either that or the old people and babies become food. You've read Cormac McCarthy's 'The Road,' right? Oprah's Book Club. Can't beat it.

[longtimelurker]

Nudge,

As far as using cash for purchases - it had been a choice of mine also for many years. However, now for most purchases, I'll use a "rewards" credit card and then pay the balance off monthly. Either that, or take up the store on their 18-24 months 0% interest deal, pay the monthly minimums, then pay off the remaining balance as the deal is expiring. Thanks to $ devaluation the money at the end of term is worth less than it was when I made the initial purchase, thereby making what I bought that much less expensive.

A few years back when CC's were even giving 0% interest/0% balance transfer fee deals, I'd transfer balances as one deal was expiring to another card, using their "money" for years on end, interest free. Of course, always having the cash invested elsewhere, earning for me. I've never paid ANY CC interest, and they apparently love me based on the 5+ offers I receive in the mail per week up to this day.

The last purchase I made on credit that I didn't have cash in reserve to cover was my condo. Soon I will be able to pay off the balance there too, but choose not to, for the same reason as mentioned above regarding $ devaluation. As long as the dollar devalues at a rate higher than my mortgage rate, I'm good there, too.