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We have entered one of those periods when things are happening so fast it’s difficult to update one’s mental maps in a meaningful way. You know what was there, but you don’t know what’s there now. The last time I felt this way was in the fall of 1989 when the Iron Curtain fell. The map was crumbling.

In the past week we’ve learned that because of “language arbitrage,” another word for sharp business dealings, the entire CDS market is compromised. The Greek default may be deemed “voluntary” by the banks who wrote the worthless paper, and, surprise surprise, also comprise the “regulatory agency” that makes the rules about what is and is not a default.

As the formidable Reggie Middleton says, the CDS market is shot to hell one way or the other, and the five big banks that hold the vast majority of the trillions of dollars of exposure and now effectively unhedged.

It’s a Mexican standoff. Can we trust bankers to honor the rules of Mutual Assured Destruction? Not hardly. Look at how Hank Paulson took advantage of the opportunity to nuke Lehman. At the first whiff of blood in the water the sharks will attack.

The miracle cure of inflation, which really would have been a better way to get out from under bad debt, is not going to happen in a debt deflation. In the banks unwillingness to recognize that their bad debt is not going to be repaid in full, and the whorish accounting profession’s willingness to let them carry it at fictitious values on their books, the downward spiral of debt deflation is guaranteed.

One of the scariest things I’ve seen this Halloween was an interview with Larry Fink of Blackrock Investments on FT in which he (licking his lips) expressed a willingness on the part of the trillions of dollars of Big Money parked on the sidelines worldwide to participate in the rebuilding of some of these troubled economies at equity-like rates of return (with credit enhancements provided by governments and the IMF, if they could only learn how to behave and keep mostly out of the way)….

If the Greeks are smart they’ll tell the EU to shove and just default on their debts. Once bad debts are written down, it’s amazing how quickly new money can appear.

The world economy will stagnate and tend toward war until honesty returns to the financial statements of the big banks.

As John Hussman has pointed out recently, and as I’ve pointed out all along, the failure of big financial institutions does not necessarily mean the economy falls into depression. In the 1930s, the problem was that deposits were wiped out. All the Feds had to do when the crisis hit was to tell Americans their deposits were insured. When a bank fails, the biggest change from a depositor’s point of view is that the sign changes.

Would the investors in the bank, equity holders and probably most bond holders, have been wiped out? Sure. That’s what risk taking is all about.

But our leaders elected to send good money after bad, and bail the banks out on the taxpayers’ backs. The Germans and French and Americans should just admit they made some really bad loans—and were stupid enough to believe the toilet paper CDSs they were selling each other were actually going to protect them from anything. But then, the big banks were stupid enough, in some cases, to hold the “AAA'” securitizations of sub-prime mortgage paper that Wall Street conned them into creating on their own balance sheets.

There’s plenty of equity-backed liquidity sitting on corporate balance sheets.

Can the global financial oligarchy survive a Mexican standoff? That’s what this historical moment will decide.

And if the oligarchs turn to fratricide, and the strongest become even stronger, and exercise their greed even more, how long until the population of the world coalesces into a hard-edged resistance to financial feudalism through outright rebellion?

Source: Mexican Standoff