What Will We Do with All That Debt?

What will we do with all this debt?

I’ve been trying to get an answer to that question and thus far I’ve failed miserably.

It should be obvious by now that the fundamental problem we face is that there is too much debt. The entire Western world borrowed against everything in sight to buy everything that wasn’t in sight. For the purposes of this article it doesn’t matter how we got here; the fact remains that there is way too much debt, and as time goes by the situation gets worse and not better. Is there any realistic hope that all the debt created in the “credit bubble” will ever be honored? I don’t think there is; in fact I am nearly certain there isn’t.

We can debate for years, and in fact we have been, about how best to “fix” this problem. But there really isn’t any chance of that, is there? Can the blow be softened or stretched out? Sure. Will the debt ever be honored? Not a chance in Hell.

So let’s examine all the paths that debt might take, from my incredibly simplistic layman’s view, uncluttered by all the monetarist BS one learns in B-school, and from this we might be able to develop a strategy for making money, or at least living to fight another day.

There are two, and only two, paths that debt may take. It can be paid, or it can be dishonored.

1. Pay the Debt

Debtors borrow money to spend now. Due to the “Time Value of Money” theory, money now is worth more than money in the future, so lenders charge interest for the privilege of borrowing money in the present. How can this debt be paid off? If it is debt for a productive endeavor, the debt can be paid off from the cash flow stream of the productive endeavor. Ideally, of course, the productive endeavor should include a productivity enhancement of some kind that makes the debt worthwhile. Failing that, the debt is merely future consumption brought forward in time.

A growing economy, reinvesting in itself, has the capacity to pay off debt. But what is a growing economy? I contend it is one that is ever-increasing its productivity and thus raising the general standard of living. Gains from productivity increases can pay off debt and still leave room for a profit. This reward system, in the past, has served both American business and society well. However, if debt is merely future consumption brought forward in time, then it must be paid by reduced consumption in the future, reduced by the amount of the debt plus interest.

There are no other ways to pay debt.

2. Dishonor the Debt

There are many ways to dishonor debt and I will attempt to cover them all. I want to make this important distinction: some ways to dishonor debt are “legal”, but they still dishonor it and cause real loss to the lender and real destruction of the lender’s capital.

a. Repudiation: debt that cannot be paid can simply be repudiated, and often is: “I’m not going to pay you.” The loss to the lender is obvious in this case.

b. Restructuring: debt that cannot be paid on contract terms can be restructured, which is usually part cramdown and part lengthening of terms. Both of these cause substantial loss to the lender; this process is properly done in the venue of bankruptcy courts, it is a legal process in which the contract between parties is enforced to the extent deemed possible by the court. A functioning judicial system equal to the task of enforcement of contract property law is THE hallmark of capitalism; without such protections capital will not come out to play.

c. Abrogation of contracts: this is a variant of “repudiation” and it is one that scares the Bejeezus out of me. As I stated above, enforcement of property contract law is the very foundation on which capitalism rests. Were any government to even begin to advocate a widespread rewriting of financial contracts, done by government bureaucrats outside of bankruptcy court, I believe capital would go into hiding and stay there. Yet, such a process is now being widely advocated as a means to “save homeowners.” Banks are being criticized by Congress for failing to renegotiate mortgages. Under normal circumstances, renegotiations would be the purview of the contract parties and no one else. But now that the banks are de facto nationalized, pressure is being applied to cramdown mortgages and cause real losses to lenders and real destruction of their capital, and it is obvious that there is no intent for these widespread cramdowns to take place inside a courtroom. If this were a mutually agreed-to action by both contract parties, then no court is necessary for capital to feel protected. In the present case, though, pressure is being applied by the same organization that also runs the courts and holds the legal monopoly on the use of force, namely government.

How will capital feel about this?

Credit Default Swaps are another abrogation risk IMO. There is a growing cry to “ban” them or to ignore them. There are plenty of “good” reasons being floated, one of the more popular is: “Some of them are just naked bets” and so they shouldn’t be allowed. Such abrogation action might help the government’s efforts to hold AIG’s and GM’s heads above water, but the damage to capital market confidence would be incalculable.

d. Currency debasement: I noted above that a growing economy has the capacity to pay debt. One way an economy can “grow” is by constantly debasing the currency, making prices and wages appear to rise and thereby constantly lowering the real burden of debt.

Let me be absolutely clear: currency debasement is a process by which debt is dishonored. If debt is repaid with currency that has less value than was borrowed, then there has been real loss to the lender as well as an incremental destruction of his capital, and a “dishonor of debt” has occurred.

What does all this mean? It means that the current “Inflation/Deflation” debate is a red herring, a “technique used in literature to mislead the audience”. In this case, the author of the literature is the Federal Reserve and the audience is you and me. I believe there is no way that all the sovereign, commercial, financial, and consumer debt can be honored in the traditional sense. And sadly, if that is true, then all that remains to be determined is which path of dishonor will be chosen, and how far down that path we will travel.

I am not a trader; I don’t want to get caught offside. Short-term (months) fluctuations in my core investments are of no concern to me. What does concern me is this: contract- based financial assets are obligations of a counterparty. In the environment I’ve just laid out, how smart is it to place one’s total faith in contract-based assets that are denominated in a fiat currency?

Disclosure: Long precious metals and miners. I am not a financial professional so please DYODD.

Comments

[MGA_1:]

Sigh.... I hate to say it but I think the US will eventually default in some way - either huge inflation, reducing the yields on T Bills or simply saying they won't pay. Yikes !

Feb 21 09:38 AM

[y3115y:]

We printed large amount of money during WII, we paid it by inflation, total 30% in the post war five-year period. During those five years, the inflation rate was not equal every year.

Feb 21 09:40 AM

[SW Richmond:]

Consider-this,

I agree completely that Chinese mercantilism cannot persist and that the Chinese were stupid to pursue it as long as they did; this has been a conundrum for me. How did they let themselves get into this position? What were they thinking? I have speculated elsewhere that there didn't exist, and still doesn't exist, a critical mass of financial specialists in China who understood market forces, but then again we supposedly had one here and look what it got us. It's tempting for me to guess that the Maoists purged anyone with knowledge of capitalism, and as a result the Chinese were unprepared for what came their way when they unleashed it. We obviously have too many here, maybe we could loan some of our "experts" to the Chinese. Paulson's available, I hear.

It would certainly have been easier for China to make a change during boom years. Do they have sufficient reserves to support their domestic situation while they shift to domestic consumption? I can't tell from where I sit. I can see them beginning to buy up commodity producers at depressed prices, and time will tell whether they keep this up. I think this is one way they are going to diversify out of USD-denominated assets. It makes perfect sense for them to talk up their support of the Treasury market while quietly moving out of it. Interestingly, their USD reserves and peg to USD helps them buy stuff in Australia and elsewhere due to USD strength.

I have also been exposed to the theories that essentially require a reserve currency nation to run perpetual deficits in order to keep the world supplied with its reserve currency. Frankly, I'm not sure what to make of them.

I overreact when someone tries to tell me that there's a solution here for the US that involves more debt, at an accelerated accumulation rate, for the US taxpayer. IMO this simply isn't possible without US currency devaluation. It may be merely part of a coordinated global devaluation, which preserves apparent USD "strength" wrt other currencies, but commodities are where this rubber meets the road. We are seeing skepticism about this right now in the price of gold.

Feb 21 09:44 AM

[Alan Brochs...:]

excellent point. My blog (ab.typepad.com) discusses the timing of the possible inflation (article dated 2/20, should be up on Seeking Alpha shortly). I didn't address your point directly, but it crossed my mind as I was reviewing the data. Notice, in this instance, how long it took for the inflationary event to transpire after the deflationary pressures...


On Feb 21 09:40 AM y3115y wrote:

> We printed large amount of money during WII, we paid it by inflation,
> total 30% in the post war five-year period. During those five years,
> the inflation rate was not equal every year.

Feb 21 10:35 AM

[SW Richmond:]

Alan / y3115y,

The environment in 2009 is completely different. Information is now instantly available to tens of millions of market participants that used to either be unavailable or only available to few. While it might have taken years for the "actual" inflationary impact of monetary expansion to work its way into the system in 1950, the markets nowadays see it and react much more quickly. Much more quickly. In other words, the market's discounting mechanism works much faster due to improved information flow. The inflationary runup we experienced last year (gold to $1000, oil to $140) was a great example. The markets were reacting en masse to expectations, not actual inflation.

Feb 21 10:57 AM

[Bobco23:]

"What would *THEY* do with with all that debt (US dollars)?"

I can't answer that, but I know what most of *US* would do if we were controlling their portfolios; buy natural resource assets, e.g., FCX, BP, NEM, CVX, etc. Ultimately, that would not be good for this nation.


On Feb 20 05:46 PM Consider_this wrote:

> Perhaps you should switch the title and you'll see the different
> perspective:
>
> "What will *THEY* do with all that debt? (and US dollar)"
>
> This is as big, if not a bigger problem, for the exporters as it
> is for the USA.
>
> Say the foreign country bought US dollar (to prevent their currency
> from rising, or to debase their currency); and the USD is used to
> buy UST.
> Now the UST matures. They now get USD back *PLUS INTEREST*, so more
> USD than before. They now have another problem.
>
> If they should sell the USD on the open market, it'll strengthen
> their own currency. With the interest and their original manipulation;
> their currency likely to end up even stronger than what they started
> with if they sell USD this way. So see the export conundrum I highlighted
> above.
>
> If they're unwilling to approach this problem; now they have USD
> to buy US denominated things. In fact, with a running export engine,
> they probably have even more USD from their own trades, on top of
> this newed matured UST income. So they have to buy something. (or
> US Govt will run inflation at 2-3% and kill their raw cash store
> in 30 years anyhow)
>
> So this is how the story of how an appetite for USD debts grows...
>
>
> The solution for Asia is simple. Let your currency be strong. But
> the conundrum is real -- let your populace be unemployed and your
> economy be wrecked in the process.
>
> Back to the topic of the US Gov... Once it has issued a debt, it
> has rarely ever completely repaid it and be done with it. (Since
> the whole UST ballooned from Regan years, only in a brief period
> in Clinton's years did US debt ever dropped.) Instead, the debt is
> perpetual like lithgowk said. So the question is not whether we can
> afford the debt, it's whether we can roll it over to the new debt.
>
>
> With the Asian conundrum listed above, unless Asia starts to accept
> a strong Asian currency, the USDs to roll over new debt will exist.
> This ability will exist until their currency manipulation becomes
> untenable (long way away from that); or we overwhelm them with the
> amount of new debt we create (a real danger, but currently not observed
> yet.. USD is still climbing)
>
> Now... the least painful way to resolve this, is for Asia to lead
> by having a strong currency and internal market. But the timing's
> got to be right too... They cannot turn around when the global economy
> is in the tubes.
>
> Their chance to change is during boom years. The last boom years,
> China had a chance to switch if it hadn't insisted on serious pegging
> of it's currency and running exports to sky high growth rates. It
> didn't listen. So now it's stuck with the decision it made back then.
>
>
> If the globe ever returns into a growth period agan, then Asia has
> to start sacrificing export gains and build internal demand. But
> that's akin to asking a stock addict to not double down when equities
> are climbing; but to sacrifice gains and diversify instead -- how
> many of us listen to this???

Feb 21 10:58 AM

[antiquary:]

As a percentage of GDP, we had far more debt than this at the end of WWII, and paid it off. I think the central position of cheap leverage in the current Idioticon of blame for the situation has sobered everyone up about it. With less pressure by ordinary citizens on government to overextend itself for their pet cause(s) in the future, we'll pay it off.

Feb 21 11:07 AM

[Philip Gvinter:]

There is a logical flaw in the argument against currency debasement and for the use of the time value of money. The flaw lies in the fact that the time value of money is based on projected estimates of currency debasement. The only reason that the money is worth more today and therefore being charged interest on is because it will be worth less tomorrow. This can only be a result of the creation of more money, which would thereby devalue the existing supply.

Currency debasement is an absolute necessity in our current global financial system, the key is to manage policy in such a way as to provide slow steady debasement which can more predictably be priced into the flow of credit. A disruption in such policy can lead to stagnation or out of control inflation.

During the previous "growth" cycle of 2003-2007 we had extremely high levels of asset price inflation coupled with a lack of wage inflation. The risk which such a situation represents were not properly recognized and an excessive level of unsustainable credit decisions were granted. The problems were global and systemic. Without coordinated and carefully calculated global efforts the entire system can become insolvent and collapse.

Feb 21 11:09 AM

[henarl:]

Inflation has been the time honored method of debt reduction thruout human history. As long as it is a gradual debasement, capital has and will continue to "come out to play" as it really has no long term alternative. The problem occurs when the inflation, or fear of inflation, accelerates to the point where it causes lending to dry up. That would appear to be where we are now and governments attempts to accelerate inflation are counterproductive and will only incentivize further deflation.

Feb 21 11:48 AM

[Alan Brochs...:]

I think your point is quite informative. The relative speed of information has been transformational in many ways. The supply chains can go from all out to a dead stop on a dime, as all of the layers are now connected almost real-time. Theoretically, this should actually dampen, not magnify cyclicality. We shouldn't ever be producing too much or too little (no more inventory cycles).

Demand destruction is what is different now, not the flow of info (which has been getting better for 15 years or so). Also, the role of the speculator at the margin (hedge-funds). While you attribute the run-up in gold (I'll leave that alone) and oil to inflation, I am not sure that is the correct conclusion. Oil was a perceived shortage. It was irrational at 147 and probably irrational now (not sure). It isn't the information speed that is the driver, it is the speed of speculative money chasing too few opportunities.


On Feb 21 10:57 AM SW Richmond wrote:

> Alan / y3115y,
>
> The environment in 2009 is completely different. Information is now
> instantly available to tens of millions of market participants that
> used to either be unavailable or only available to few. While it
> might have taken years for the "actual" inflationary impact of monetary
> expansion to work its way into the system in 1950, the markets nowadays
> see it and react much more quickly. Much more quickly. In other words,
> the market's discounting mechanism works much faster due to improved
> information flow. The inflationary runup we experienced last year
> (gold to $1000, oil to $140) was a great example. The markets were
> reacting en masse to expectations, not actual inflation.
>

Feb 21 11:52 AM

[kelm:]

As a percentage of GDP the Federal debt is lower now than at the end of WWII.

However, the total US debt, federal, state, corporate, personal, municipal was at a LOW point right after WWII. We are many times higher now. This total debt is what impairs the economy as it represents the total burden on economic activity. Further, as he bailouts continue increasing amounts of that corporate, personal, and soon state and municipal debt will find their ways onto the Federal books.


On Feb 21 11:07 AM antiquary wrote:

> As a percentage of GDP, we had far more debt than this at the end
> of WWII, and paid it off. I think the central position of cheap
> leverage in the current Idioticon of blame for the situation has
> sobered everyone up about it. With less pressure by ordinary citizens
> on government to overextend itself for their pet cause(s) in the
> future, we'll pay it off.

Feb 21 12:19 PM

[Smarty_Pants:]

" OK, so we know exactly what a stimulus will cost us: probably 1-3 Trillion." - Chris B.

Isn't is amazing how easily we have become accustomed to tossing around "Trillions" without thinking about what that actually represents?

It's a big number folks. Really big. So big most people have a hard time wrapping their brain around it.

Here's one perspective that might help you grasp just how much money that represents.

$1 Trillion:

Take $1 Trillion in hundred dollar bills and tape them together end-to-end, then roll them up on a dowel like a roll of toilet paper.

Attach the free end to a jet fighter flying at the speed of sound and let the roll unwind as the fighter flies away.

The pilot has to keep flying at the speed of sound for over 50 days to unwind the entire roll of $100 bills.

He has to keep flying at the speed of sound almost 9 years to unroll the $65 Trillion negative net worth of the US Government.

Great article SWRichmond. As usual, you hit the nail on the head. At this point any 'solution' will be painful for someone, the question is who gets the gold and who gets the shaft?

About the only thing I can state with a high degree of certainty is that more gub'mint ain't the answer to this problem.

Expect hard times to come in the near future as the world deals with the corner we've painted ourselves into.

Feb 21 02:49 PM

[PROXIMO:]

Terrific analogy with the jet fighter. Makes the size of the problem more real. Just curious--as the government is by far the largest property owner in the country (national parks, bridges, airports, Washington DC, roads-Interstates,high... federal and state municipalities, raw acreage etc.,) does the 65 trillion negative net worth include those properties? As that would be many trillions.


On Feb 21 02:49 PM Smarty_Pants wrote:

> " OK, so we know exactly what a stimulus will cost us: probably 1-3
> Trillion." - Chris B.
>
> Isn't is amazing how easily we have become accustomed to tossing
> around "Trillions" without thinking about what that actually represents?
>
>
> It's a big number folks. Really big. So big most people have a
> hard time wrapping their brain around it.
>
> Here's one perspective that might help you grasp just how much money
> that represents.
>
> $1 Trillion:
>
> Take $1 Trillion in hundred dollar bills and tape them together end-to-end,
> then roll them up on a dowel like a roll of toilet paper.
>
> Attach the free end to a jet fighter flying at the speed of sound
> and let the roll unwind as the fighter flies away.
>
> The pilot has to keep flying at the speed of sound for over 50 days
> to unwind the entire roll of $100 bills.
>
> He has to keep flying at the speed of sound almost 9 years to unroll
> the $65 Trillion negative net worth of the US Government.
>
> Great article SWRichmond. As usual, you hit the nail on the head.
> At this point any 'solution' will be painful for someone, the question
> is who gets the gold and who gets the shaft?
>
> About the only thing I can state with a high degree of certainty
> is that more gub'mint ain't the answer to this problem.
>
> Expect hard times to come in the near future as the world deals with
> the corner we've painted ourselves into.

Feb 21 09:42 PM

[Aristophanes:]

CDO's are contracts that wrap contracts that wrap contracts, that wrap contracts. A big onion of contracts.

CDS's are insurance. However, as both CDO's and CDS's are part of the essentially unregulated shadow banking system, the standards that underlie them are extremely varied and thus complex.

For CDS's the largest factor (and the one that sank AIG and is killing the Irish banks and hedge funds) is that there is no capital reserve requirement. In fact, you can even leverage the premium! As for dishonouring a CDS, that's usually determined by liquidity. So when all ships go down with the tide, counterparty risk rises commensurately.

The value, liabilities and risks of formal mortgage backed CDO's, on the other hand, are based on the original assessments of the mortgages themselves, including the borrower's fundamentals. Assessing those fundamentals has been common civil law for generations until securitization. There is ample legal precedent to show that a flawed product can lead to contractual abrogation. It's done all the time. Ask yourself this question: Did the pension plan I pay into have a proper risk assessment done on the mortgages it bought using common standards? I many case, the answer is no.

To stand by CDO's as inviolate from contractual rewrite is to accept at face value the original triple-A's these things received throughout the spectrum. A loan is non-performing when payments are not coming in. The onion is then deemed non-performing when the security cannot be re-sold or when x amount of loans fail to perform up to grade. This is all unregulated. Who knows? That's why they are toxic black boxes. All we know is that the inability to sell them without bankrupting the holder, and their continuous depreciation as rational defaults and other economic woes take hold, is starving the markets of functional banks.

You have to remember that the foreclosure process is a shortcut in quasi-judicial financial contract enforcement. Because real property is at stake, the system has been curtailed to a quick, no appeal process and the original contract is not reviewed. These contracts were awful to begin with. In many new developments, were based on the fact that the developers over-built and needed to unload risk quickly. So they gamed the qualifications. Securitization gave cover to the enterprise by (supposedly) spreading the risk. What it did is made the risk more like a line of dominoes.

That's why the bankruptcy threat by the Obama Administration might not be a bad thing. Sure, mortgages will get more expensive. But they would also get a lot more honest.

What we do know is that each mortgage represents a local piece of land somewhere that can be more realistically assessed for real value by local realtors and banks. These bundled systems cannot get it right. They are too slow and cumbersome. The only way the true value can be assessed is over a lot of time; or by breaking them up into individual mortgages and letting the market determine real worth.

Frankly, all it will take in CDO or tranche is for a single court precedent to determine a type of loan is ab initio, at which point a cramdown will occur. Obama is trying to isolate the "rational default' segment o the problem and address it to take the edge off, with a court mandated solution also in the cards if banks don;t rewrite these same mortgages and cull their losses.

I am not sure it will do any good. Ultimately I think that these CDO's and CDS's will all have to be registered with the government and then the Administration will have to choose which banks, hedge funds, brokerages, insurers, etc. will live and which will die. The interesting thing about the CDS's is that many of them can be annulled due to corresponding obligations. it's the CDO's that are the killers here. They are hitting Main St. hard. Markets for securities are so dead that Geithner's attempt to revive them is both foolish and in many ways, immoral.

So sad. So preventable.



On Feb 21 09:22 AM SW Richmond wrote:

> Aristophanes,
>
> "If the original signatories of a contract are both understood to
> be non-performing in execution (no market for the collateralized
> mortgage securities and inability to pay the reset interest rate
> mortgage) then there is consensus that the original contract is flawed
> from inception. You do not need a court to validate that (in fact,
> that just adds more lawyer's fees to the process). Government in
> this case is simply acting as the mediator of last resort. Given
> the scale of the problem, that is what government does"
>
> Thanks for this info, very interesting. I'd really like to read
> more about the conditions under which this is done, especially under
> which it MIGHT be done wrt CDO / CDS. How is the determination made
> that both parties are non-performing? Is there any redress against
> a determination being made over your objection?
>
> My specific thoughts right now regarding CDS, for example, is that
> they were written at a time when (most) everyone had a stout balance
> sheet and looked like they could perform if called upon, but now
> that so many counterparties have shredded balance sheets I can envision
> (from where I sit at least) a condition where both / all parties
> to a CDS could be found to be incapable of performing. It's also
> my understanding that some of them may have been written strictly
> as off-track bets.
>
> Any additional info, link, book title, etc would really be appreciated.
> Thanks!

Feb 21 09:59 PM

[sidestick:]

You can buy all the "Ameros" you want on Ebay... but the sellers require payment in USD! Do a Google search.


On Feb 20 09:48 AM El Sabio2 wrote:

> Good question and a good answer. In fact probably the most critical
> question of our times.
> Let's face it the only real solution is to create massive inflation.
> The goons that got us into this mess will buy TIPS and / or Gold
> - there is no other solution. Thereafter the dollar will disappear
> and they will create a merged NAFTA / Euro coin........anybody seen
> the AMERO project?

Feb 21 10:18 PM

[ArtfulDodger:]

SW Richmond:

Very good article. I like your disclosure a lot. Keep up the good work. Thank you.

Feb 22 02:44 AM

[PROXIMO:]

Aristophanes---Why not submit an article to SA to post? Your comments on SA seem to be typically well-received. And, IMO, it's not like you wouldn't "belong" with the finest authors posting on SA. Some of what you say would certainly go over some readers' heads, as it does mine, but they, and I, could appreciate the majority of your remarks. I have no idea what is involved in getting an article published on SA, or if you'd be remotely interested. Just my thoughts---Prox


On Feb 21 09:59 PM Aristophanes wrote:

> CDO's are contracts that wrap contracts that wrap contracts, that
> wrap contracts. A big onion of contracts.
>
> CDS's are insurance. However, as both CDO's and CDS's are part of
> the essentially unregulated shadow banking system, the standards
> that underlie them are extremely varied and thus complex.
>
> For CDS's the largest factor (and the one that sank AIG and is killing
> the Irish banks and hedge funds) is that there is no capital reserve
> requirement. In fact, you can even leverage the premium! As for dishonouring
> a CDS, that's usually determined by liquidity. So when all ships
> go down with the tide, counterparty risk rises commensurately.<br/...
>
> The value, liabilities and risks of formal mortgage backed CDO's,
> on the other hand, are based on the original assessments of the mortgages
> themselves, including the borrower's fundamentals. Assessing those
> fundamentals has been common civil law for generations until securitization.
> There is ample legal precedent to show that a flawed product can
> lead to contractual abrogation. It's done all the time. Ask yourself
> this question: Did the pension plan I pay into have a proper risk
> assessment done on the mortgages it bought using common standards?
> I many case, the answer is no.
>
> To stand by CDO's as inviolate from contractual rewrite is to accept
> at face value the original triple-A's these things received throughout
> the spectrum. A loan is non-performing when payments are not coming
> in. The onion is then deemed non-performing when the security cannot
> be re-sold or when x amount of loans fail to perform up to grade.
> This is all unregulated. Who knows? That's why they are toxic black
> boxes. All we know is that the inability to sell them without bankrupting
> the holder, and their continuous depreciation as rational defaults
> and other economic woes take hold, is starving the markets of functional
> banks.
>
> You have to remember that the foreclosure process is a shortcut in
> quasi-judicial financial contract enforcement. Because real property
> is at stake, the system has been curtailed to a quick, no appeal
> process and the original contract is not reviewed. These contracts
> were awful to begin with. In many new developments, were based on
> the fact that the developers over-built and needed to unload risk
> quickly. So they gamed the qualifications. Securitization gave cover
> to the enterprise by (supposedly) spreading the risk. What it did
> is made the risk more like a line of dominoes.
>
> That's why the bankruptcy threat by the Obama Administration might
> not be a bad thing. Sure, mortgages will get more expensive. But
> they would also get a lot more honest.
>
> What we do know is that each mortgage represents a local piece of
> land somewhere that can be more realistically assessed for real value
> by local realtors and banks. These bundled systems cannot get it
> right. They are too slow and cumbersome. The only way the true value
> can be assessed is over a lot of time; or by breaking them up into
> individual mortgages and letting the market determine real worth.
>
>
> Frankly, all it will take in CDO or tranche is for a single court
> precedent to determine a type of loan is ab initio, at which point
> a cramdown will occur. Obama is trying to isolate the "rational default'
> segment o the problem and address it to take the edge off, with a
> court mandated solution also in the cards if banks don;t rewrite
> these same mortgages and cull their losses.
>
> I am not sure it will do any good. Ultimately I think that these
> CDO's and CDS's will all have to be registered with the government
> and then the Administration will have to choose which banks, hedge
> funds, brokerages, insurers, etc. will live and which will die. The
> interesting thing about the CDS's is that many of them can be annulled
> due to corresponding obligations. it's the CDO's that are the killers
> here. They are hitting Main St. hard. Markets for securities are
> so dead that Geithner's attempt to revive them is both foolish and
> in many ways, immoral.
>
> So sad. So preventable.
>

Feb 22 12:01 PM

[Chancer:]

Bernanke said that he was considering having Fed purchase T Bills. That is like we are financing our own debt and far better than owing China.

For example, Ben B. has Fed buy $10 T (for trillion) of T Bills. Fed has asset receivable and Treasury has liability payable.

Then, once per year Ben sends a post-it note to the Treasury Secretary that he is writing off (forgiving) 20% of the debt. Both the Fed and Treasury write down on their books, and in 5 years it is all "gone"- "poof."

What a wonderful country: The United Enron States of America.

Feb 22 08:08 PM

[Kunst:]

We don't have to issue bonds denominated in yen, or any other foreign currency, as long as other nations are willing to take dollars for real goods.


On Feb 20 11:27 AM SW Richmond wrote:

> Consider,
>
> I understand that; my point is that what you are really doing is
> to allow the US to continue to export inflation, which is the path
> that got us here in the first place. Also, please note that the
> Japanese have some months ago begun to suggest they might like to
> see future lending by them to our government denominated in Yen.

Feb 23 02:10 AM

[Consider_this:]

On Feb 21 09:44 AM SW Richmond wrote:

> Consider-this,
>
> I agree completely that Chinese mercantilism cannot persist and that
> the Chinese were stupid to pursue it as long as they did; this has
> been a conundrum for me. How did they let themselves get into this
> position? What were they thinking? I have speculated elsewhere
> that there didn't exist, and still doesn't exist, a critical mass
> of financial specialists in China who understood market forces, but
> then again we supposedly had one here and look what it got us. It's
> tempting for me to guess that the Maoists purged anyone with knowledge
> of capitalism, and as a result the Chinese were unprepared for what
> came their way when they unleashed it. We obviously have too many
> here, maybe we could loan some of our "experts" to the Chinese.
> Paulson's available, I hear.

China saw what Japan and 5 tigers could do in the 1980s; so it followed suit, pretty much copying the model. By the time it's apparent that Japanese mercantilism is a dead end and is synonymous to forever being led around by the USA, it's too late to withdraw. It's not a lack of expert advise. No expert can prevent pain, and it's human nature to shy away from pain, so this issue never gets solved. It's like asking how did Social Security become such a big problem? Why didn't anyone tackle it? We don't have a lack of experts: It's against human nature to face significant pain when you don't have to.

>
> It would certainly have been easier for China to make a change during
> boom years. Do they have sufficient reserves to support their domestic
> situation while they shift to domestic consumption? I can't tell
> from where I sit. I can see them beginning to buy up commodity
> producers at depressed prices, and time will tell whether they keep
> this up. I think this is one way they are going to diversify out
> of USD-denominated assets. It makes perfect sense for them to talk
> up their support of the Treasury market while quietly moving out
> of it. Interestingly, their USD reserves and peg to USD helps them
> buy stuff in Australia and elsewhere due to USD strength.

China cannot supplant US Consumer's buying power. US Consumer is 7 times bigger than their internal buying power. They'll have to grow an internal market 300% just to lose more than 50% growth -- and they started too late. Yes, they're doing some pretty drastic things like a 30% govt subsidy for electronics and appliance; mortgage interest discounts and other business loan assistance. But by the time they issued internal stimulus plans, people in exports have already lost jobs. Who buys stuff when you have no job, no matter the discounts or govt subsidy? If 70% of their workforce is in export, export support or imports for export bridging industry (i.e. imports to help support exports) type business, it's an uphill battle to combat growth slowing.

The problem of buying assets with USD doesn't remove USD from the market. So China give Australia USD to buy their company A. Now that chunk of USD is an Australia problem. Thinking it through, it'll show that now Aus have to buy UST instead of China. (or let it's currency raise) Pot-a-toe, Pota-toe who's owner doesn't make a difference to the seller of UST -- the USA.

So there's a limit how many actual resource they can buy before other countries enact protections.

Globally, NOBODY'S (minus USA) is willing to let their currency climb with respect to everyone one. If someone will take that lead (and have the capacity to), he'll become the next superpower. It's the most ironic thing ever: the climb to financial superpower is simply the willingness to let others bank inside yourself; to take up the liability to be someone's bank. (See my next paragraph to see some sense on this)

>
> I have also been exposed to the theories that essentially require
> a reserve currency nation to run perpetual deficits in order to keep
> the world supplied with its reserve currency. Frankly, I'm not sure
> what to make of them.
>

This theory is true to a degree. More concisely, you need someone to run deficit, as long as you have players in the system, that (for whatever reason) wants to save more than they make. This is because you cannot create savings out of thin air in a global system. Your savings is someone else's liability problem, always is, always will be. Think about it and it makes sense.

Even gold backed, this is still true. I can "save" by buying gold and storing it into a celler. This effectively removes that gold from circulation and layers on a "liability burden" onto the whole system by causing slight inflation. (inflation because now there's less gold to chase after goods)

But unless I'm a miser (who saves just because, and not for some future USE) isn't that "savings" simply trusting that this gold can be resold back when I need to spend my savings for something else? "Reselling" at that time is simply claiming the liability back from the system. The slight inflation will now be reset, and I can then claim that difference from my sales.

If the system have no capacity for such liability claim by the time I want to sell the gold (to claim my savings), then my gold will be sold for a pittance or maybe even no demand for the sales. Imagine if there's a plague and very few people is left in the world -- gold won't allow you to buy a new house construction even if I wanted to -- because the ability to build that house no longer exist in the new system. (i.e. "no capacity for such liability claim")

> I overreact when someone tries to tell me that there's a solution
> here for the US that involves more debt, at an accelerated accumulation
> rate, for the US taxpayer. IMO this simply isn't possible without
> US currency devaluation. It may be merely part of a coordinated
> global devaluation, which preserves apparent USD "strength" wrt other
> currencies, but commodities are where this rubber meets the road.
> We are seeing skepticism about this right now in the price of gold.

The solution will not be a "USA" solution, despite how much we want it. Similarly, it won't be a China solution, either. It's going to be some balance that we'll reach, that looking at the system in isolation from with USA side or China side, would seem utterly dysfunctional. But a dysfunctional system can be remarkably stable.

The only way you can get true USA solution, is to cut off global trade period. *FORCE* self-sufficiency within the USA. Everyone's lives will be made worse, but we'll reach an equilibrium that makes more sense analytically than now. But that's trying to make something sensible by forcing it to be.

Feb 23 11:53 AM