First - Lehman's CDS and bond auction process told us two things:
* Even though they were dirtier than a hobo who hadn't had a bath in a month, they had enough value left in their bonds to wind up positive. Yes, it was less than a dime on the dollar. But it was a positive number. That's all that matters.
* There were no fails on the posting of collateral against settlement.

Now for the last year we have been told that:
* You can't trigger the CDS, it will cause a systemic, chain-reaction style nuclear meltdown.
* These firms are so broke that there is no value left in them.

Both are now known to be false.

This gives us hope - and a path out of the darkness.

It’s called "The Genesis Plan" (See attached PDF file)

The question raised about this plan is whether the "cramdown" provisions could possibly work - that is, if put through them, would the firm come out the other end, or be squashed like a bug as there was insufficient equity left in the bonds.

We now know the answer for one of the worst of the ugly - the equity is there, even if only by a scrape, to clear the firm's balance sheet and spit it out on the other side.

Folks, if there was a time to absolutely flood your Congressmen, the media, and every pundit and wonk you can find, this is it.

The short version of The Genesis Plan is:
1. Everyone must expose their balance sheet; all Level 2 and 3 assets must be declared and all models disclosed in full immediately and every quarter hereafter.
2. The CDS monster must be caged by forcing it onto an exchange where O/I and margin supervision can be maintained. This is already in process and must be completed.
3. Leverage must be returned to no more than 12:1 across the system - no exceptions.

The last point is obvious - every firm that has detonated has had leverage well beyond 12:1. None that have had less leverage have blown up. Game, set, match.
#2 is obvious and in process.

This leaves #1.
Now doing #1 will cause some insolvencies to be uncovered. Maybe a lot of them.

For each of those firms perform a "cramdown" of the debt to equity, using the retained value in the bonds to cover the liabilities that rendered the firm insolvent.

If there is recovery value (in most cases there will be, as we saw with Lehman) then the bondholders get newly-issued equity in ratable proportion to their (former) ownership of the bonds. The existing equity is wiped out. The firm, having no balance sheet debt whatsoever, can then immediately raise capital in the market to recapitalize itself (having a clean balance sheet this is a trivial task)

For those firms that have zero equity remaining, the government can step in and inject capital via a super-senior tranche as necessary to establish a working capital base. Remember, with a 6% Tier 1 capital requirement a little goes a long way - $10 billion injected results in over $160 billion of available gearing! Bingo - the firm is back on its feet. Protect the taxpayer in these transactions by attaching an onerous coupon to the issue so that it will be rapidly repaid (e.g. 3mo LIBOR + 600 bips) and cleared.

The objection to this plan will be that existing equity holders will be wiped out and bondholders will take a haircut.

Well, bond holders are no worse off than if the firm went under. They would get their recovery value anyway, and they still do - its just in the form of equity instead of cash.

As for equity holders, they're wiped out in a bankruptcy too.

The real objection to this is going to come from the executives, who will see their stock options rendered worthless along with their restricted shares. However, they remain in place (if the shareholders will have 'em) and as a consequence can rebuild their equity over time.

I have a solution for that problem too - make clear that any firm that turns down this demand is free to do so, but they will receive exactly zero access to the discount window or any other Fed or government borrowing facility, and if they go down, that's too bad - no help. We let Mr. Market take care of 'ya. Either take this deal now, or take your chances.

The Genesis Plan is demonstrably superior to the TARP/EESA for the following reasons:
1. The Genesis Plan immediately restores trust to the credit markets as balance sheets are instantaneously exposed and remain able to be evaluated by the marketplace. EESA does nothing to guarantee the return of trust to the credit markets as it does not deal with the underlying issue at all - the lies told by executives and firms in terms of their exposure to credit risk of all types.
2. The Genesis Plan addresses the root cause of all of the large-firm failures since the first of 2008 - excessive leverage. TARP/EESA is silent on the root cause of these business failures.
3. The Genesis Plan can be represented in a half-dozen pages of legislation. The EESA required over 100 to put in proper oversight. Since there is nothing other than ministerial activity required under The Genesis Plan and no discretion to abuse, such oversight is not necessary as with the EESA.
4. The Genesis Plan uses no taxpayer money at all for most institutions, and where taxpayer money is required it is intrinsically protected since it will sit at the top of a (new and clean) capital structure. The TARP/EESA uses all taxpayer and no private funds.
5. The Genesis Plan, when taxpayer money is used, goes directly to Tier 1 capital and thus is "high power" money; that is, it supports lending of $10-12 for every dollar put in. TARP/EESA is twelve times less efficient in the use of funds in that by purchasing assets zero leverage is obtained for each taxpayer dollar deployed.
6. The Genesis Plan promotes restoration of normal lending activity as it clears the impaired firm's balance sheet debt and immediately eliminates the issue of counterparty trust. TARP/EESA does not clear (although it does help remove items from) the firm's balance sheets and does nothing to address counterparty trust.
7. The Genesis Plan requires no lengthy administrative or "start up" time. It can literally be "up and running" immediately, with the exception of the CDS exchange, which is already under way. TARP/EESA was claimed to be required "immediately" but now is said to not be likely to actually go into effect until November at the earliest.
8. The Genesis Plan uses existing agencies who are already tasked with the required functions - auditing and reporting (OTS, OCC and the FDIC) and thus has very low "parasitic" costs. TARP/EESA establishes a new government agency and thus has a high parasitic cost requirement.
9. The Genesis Plan exposes the taxpayer to no credit risk. EESA/TARP exposes the taxpayer to $700 billion in taxpayer risk - or more.

While there were a few signs of credit market stress easing (a bit) today, there were also more anecdotes of things getting much worse. I see nothing to suggest that short-term lending has returned to normal, and until I do, I remain on high alert for the sort of disruptive events that can impact your life in very undesirable ways.

Yes, the market bounced hard today. Twice. Artificial? Maybe. Inside knowledge? More probably. Will whatever the "crackberry network" was buzzing about work? Likely not for more than a few days, but with the market this jittery, it doesn't matter - when the VIX is this high anything that makes people jump causes this sort of reaction - in either direction.

Get on it folks - plaster the media and your elected officials with the fact that we now have hard evidence that this path forward will not only work on a technical basis, but if it is adopted it will clear the credit markets almost immediately, which is the key element of this mess that must be resolved.

Any public official or media that wants to get ahold of me - the contact link works, and you're invited to use it.

We must fix this mess and we must do it now!

Douglas Middleton [Read More!]

Update 7:30 AM CT 10/10 - Overnight LIBOR has come in dramatically, but 3 month dollar LIBOR has not - in fact, it went higher. This tells you that while people do not believe the market is due to implode tomorrow - an improvement over yesterday - they also don't believe that anything will be fixed in the next few months. Thus, as of this time, the nightmare scenario remains on the table.

8:00 AM - Trading desks are reporting agencies being dumped by Chinese holders. Don't be too quick to call this "screw those evil Americans" - this smells like have to sell as opposed to want to sell. LOC seizures mean goods aren't moving which means you have to sell what you can, irrespective of price. Ditto for the price dislocation in the Treasury market. Say goodnight to what's left of the housing market - as I expected would happen – it’s done.

9:53 - Again, for the second day, no OMO (Open Market Operations) at The Fed. Read this report carefully. Note that there are no Agencies and no Treasuries left on The Fed's balance sheet. All gone. All that is left is $80 billion of crappy MBS. Bluntly, without printing raw money, The Fed is out of Treasuries with which to lend into the market, and thus cannot perform OMO anymore; they must do "other things" (like print money.) We are now officially into the twilight zone and Fed Solvency is an issue on the table. President Bush spoke again but none one word about forcing transparency among financial institutions. Raise cash now and be prepared for potential essential good and service disruptions as the supply pipelines could begin to go dry on these as soon as early next week.

Douglas Middleton [Read More!]

This is now a national emergency.

Seven trillion dollars of wealth has been vaporized in US Stocks in the last seven days alone, with five of it since the passage of that ill-designed and foolhardy "bailout" bill.

The selloff this afternoon is the "real deal." It was not caused by the stock market getting "mad", it was caused by the short-term credit market along with the Treasury market suddenly dislocating at a few minutes before the bond pit closed at 2:00 PM.

Worse is also the fact that institutional lending has essentially disappeared - both between banks and now it is choking off commercial short-term credit across the board.

It doesn't get any more serious than this. To repeat: short-term commercial credit is threatening to completely disappear from the American scene.

Every action our government has taken thus far, including repealing mark-to-market requirements have made the situation worse by further destroying confidence.

In the overnight market the futures are imploding once again; the Osaka exchange was closed in Japan after hitting its "lock limit" within minutes prior to the Nikkei opening; the Nikkei is now down ANOTHER 10%, for a total loss of nearly 20% in just two days, with Japanese banks trading "offer only" - that is, NO BID. There are rumors of government bond market fails in parts of Europe, and Iceland has essentially been cut off from the rest of the world Interbank marketplace.

Japanese banks are now firewalling themselves from European and US claims; the interbank market is about to explode. Iceland has effectively defaulted on sovereign debt and today there was a rumor that Hungary had a failed bond auction, effectively defaulting as well.

Key: Sovereign debt (that is, Treasuries from various nations) has become infected with trash - unfortunately including ours now that Fannie and Freddie were nationalized and TARP has been passed - and may fail in a cascade-style fashion across the world. If this occurs our ability to fund our government will be cut off as well, leading to a need to reduce government spending by $800 billion a year immediately. This means huge and immediate cuts to Social Security, Medicare and Military budgets - by as much as half.

Over a year ago I warned in my writings that this could happen if we did not take action. If we did not force accountability through Congress and onto our financial system. If we did not force the thieves, liars and thugs on Wall Street to take their medicine.

Instead of taking action we have sat on our collective asses and allowed Congress to pass bailout after bailout - now our stock market is down close to 40% from the top with 20% of that loss coming in just over one week!

We are facing a global DEPRESSION and the cut-off of essential goods and services in this nation if we do not stop this lunacy immediately.

Please understand - the TRUCKER who has a full load of food headed for your grocer REQUIRES commercial credit in order to fill his truck with diesel.

The local GAS STATION owner REQUIRES commercial credit to fill his underground storage tank.

The local CAR DEALER REQUIRES commercial credit to have cars - and parts - in his dealership. No credit, no car - and no car repairs.

IF THESE MARKETS DO NOT IMMEDIATELY UNFREEZE THE CONSEQUENCE WILL BE THAT FOOD AND FUEL MAY NOT FLOW TO YOUR GROCERY STORE AND GAS STATION.

Think about that very carefully and then consider whether YOU can afford to sit on your ass for one more second, or whether you have an absolute NEED to get on the phone, fax, and whatever else RIGHT NOW to your elected and appointed representatives and, if you do not get in response that they will IMMEDIATELY resolve this matter whether you will vow to band together with every one of your associates and friends, form a group consisting of everyone in your local city or town, and call a GENERAL STRIKE, refusing to both work and permit commerce to be conducted UNTIL THE LIARS ARE FORCED INTO THE OPEN, DEALT WITH, AND THE SYSTEM IS ABLE TO CLEAR.

We are quite literally out of time. This freeze in the markets WILL continue around the globe unless something is done NOW.

Every "intervention" and "promise" made by our government thus far - all of them - have been LIES.

Our government has done NOTHING to alleviate the problem and in fact every one of their "solutions" have made the situation worse - going back for more than a year.

We have "pumped liquidity" and even bailed out firms with taxpayer money, and yet the markets have not unfrozen.

They remain frozen because the root cause of the problem is that banks and other financial firms have been lying for more than a year, each quarter claiming to have "kitchen sinked" their losses only to report more the next quarter, and in some cases have gone on national TV to proclaim they're "well-capitalized" only days or weeks before they collapse!

The first question anyone asks when someone wishes to borrow money is whether or not they will get paid back. If the lender does not believe they will be able to be paid back then that loan will not be made, no matter how much money someone has available to them.

It really is that simple folks and yet this fundamental principle has been willfully and intentionally ignored for more than a year.

YOU MUST CHOOSE RIGHT NOW, TONIGHT, AS AN AMERICAN WHETHER YOU ARE GOING TO GO TO WORK TOMORROW AND PRETEND THAT NOTHING IS WRONG, OR WHETHER YOU ARE GOING TO ENGAGE IN PEACEFUL BUT FORCEFUL PROTEST IN DEMANDING THAT THIS CRISIS BE ADDRESSED NOT WITH "MORE OF THE SAME" BUT BY ARRESTING EACH AND EVERY ONE OF THE CROOKS, BY FORCING BALANCE SHEET TRANSPARENCY FOR EACH AND EVERY FIRM IN THE UNITED STATES, AND BY THEN FORCIBLY RECAPITALIZING VIA DEBT-TO-EQUITY "CRAMDOWNS" EACH AND EVERY INSOLVENT BANK AND OTHER FINANCIAL INSTITUTION, WITH TREASURY STEPPING IN WITH TAXPAYER MONEY ONLY AFTER THE TRUTH (OR FALSEHOOD) OF SOLVENCY IS ESTABLISHED IN PUBLIC WHERE WE CAN ALL SEE IT.

YOU LITERALLY MUST CHOOSE NOW, AS THE TIME TO DAWDLE AND THINK ABOUT IT HAS EXPIRED.

Douglas Middleton [Read More!]