Living in the American Mafia State

 |  Includes: C, JPM, KBE, SBFG, XLF
by: Christopher Whalen

In the late winter of 2008, a strong whiff of millenarianism had already crept into American public life. As voters flocked to the primaries in startling numbers, many Democrats became convinced that the Second Coming lay just around the corner. By contrast, sentiment among Republicans was more somber, if equally chiliastic: they quaked at prospects of a dire Last Judgment on the administration of President George W. Bush in the November presidential election. Partisans of both parties also harbored fears of Armageddon in the Middle East, if for very different reasons. Still, on that classical day of reckoning, the Ides of March, when the Four Horsemen of the Apocalypse suddenly appeared over the offices of the giant brokerage firm of Bear Stearns in lower Manhattan, almost everyone was astounded.

"Too Big To Bail: The 'Paulson Put,' Presidential Politics, and the Global Financial Meltdown"; Thomas Ferguson and Robert Johnson, International Journal of Political Economy (spring 2009)

The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government-a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF's staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we're running out of time.

"The Quiet Coup", Simon Johnson, The Atlantic Monthly, May 2009

As the two quotations at the top of this issue of The IRA suggest, the United States is suffering from twin maladies, insolvency in our financial sector and an equally powerful political dysfunction in Washington. As we said of Mexico two decades ago, Americans now live in a Mafia State that is beyond control. Our political class is entirely captive of Wall Street, the result of decades of corruption and moral decay. Our nation's capital is controlled by a criminal gang that masquerades as an elected government. And we must wait 18 months for the next election to thrown the scoundrels out.

While the rest of the global economy outside of the financial sector is basically sound, the excesses of the financial markets now threaten the entire world with deflation and prolonged economic decline. And yet the leaders of the financial sector are continuing to pretend that they have done nothing wrong. As Simon Johnson writes in The Atlantic:

But there's a deeper and more disturbing similarity: elite business interests-financiers, in the case of the U.S.-played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Like most Americans, we are angry at this state of affairs, but also a little sad. Watching the unfolding breakdown of the financial markets, we are reminded that most of the people who work in the markets are not part of the problem. It is the leaders of the largest firms and their clients in Washington who are to blame. We have dozens of resumes coming to our offices every week, but not nearly enough unemployed large bank CEOs.

No wonder that Fed Chairman Bernanke and Treasury Secretary Tim Geithner persist in their idiotic position that toxic subprime assets have true "values" of 80% of par. As we told the clients of IRA's institutional Advisory Service earlier this week:

Based on our projections and channel checks, we think that maybe the Fed staff got it wrong and put down the likely loss rate instead of the fanciful LT recovery rate embraced by Bernanke, Geithner and Summers. Truth is, the LT recovery or "Loss Given Default" (LGD) rate experience of 20-30% (which are the LT LGD rates used by Moody's, S&P for internal loss rate projections) are holding true in this cycle as in previous economic downturns and may actually be optimistic compared with the actual realized loss.

With most of the RES and CRE collateral we see in the channel trading in the 30s, it is only a matter of time before the markets force Bernanke, Geithner and Summers to abandon their desire to subsidize the large, insolvent banks and finally embrace liquidation. As we told our friend David Kotok at Cumberland Advisers, just remember to buy the bonds, not the equity, no matter what investment situation you may be considering during most of 2009. In the current environment, be a creditor, not a shareholder.

And don't forget, Q1 earning season starts in just a week's time. That's when we hear about the stellar profits at Citigroup (NYSE:C) and the rest of the US banking complex. And that's when the wheels will start to again fall of the wagon in Washington regarding the finncial crisis.

As global deflation proceeds, those with cash shall be king. Organization that have cash to use for acquisitions or asset purchases will feast in the coming weeks and months, providing new material upon which to base profits and shareholder value. We are already seeing distressed commercial properties in New York trading below 50% of the last valuation. How can Bernanke, Summers & Geithner ignore the falling assets prices in the marketplace?

And there are literally dozens of CRE properties in New York and the surrounding area that will be going into foreclosure and liquidation this year, perhaps even in Q2 2009. That sound you hear in the distance is the dinner bell ringing for cash investors.

Click here to read the entire issue of The Institutional Risk Analyst, including the interview with Rurban Financial (NASDAQ:RBNF) CEO Ken Joyce.