There have been many treatises written on the Credit Bubble, its causes and who's responsible.

There are lots of arrows to cast at both Republicans and Democrats.  You can trivially find things like the CRA, or what look suspiciously like bribes on mortgage rates (sub-market rates given to "Friends of Angelo" from Countrywide, etc) handed out to Congress people, and other abuses.

You can find hundreds of thousands of dollars given in campaign contributions.

All of these factors contributed to the bubble.

But if you want to know why it happened - why the market did not step in and stop it, which everyone involved wrings their hands and laments - you need to look to only two decisions, and both of those decisions were made not by Congress but by executive fiat in the Bush Administration.

These were:

1. The decision to file suit to overturn state regulation of mortgage issuers, specifically targeting New York among other states, where state regulations required that "ability to pay" (and other anti-abusive lending provisions) be part of the underwriting decision.  These suits barred states from clamping down on lenders who made loans to people who could not pay.
2. The decision by the SEC to lift broker/dealer leverage limits in 2004.

#2 is particularly outrageous because in 2000 Henry Paulson, then the head of Goldman Sachs, asked the SEC to lift those limits and was told "no" - The SEC at the time said that it believed that removing those limits was unsafe.

In 2004 Henry Paulson (two years before he came to Treasury) came back with the request a second time, and the request was granted in what was the culmination of a furious lobbying crusade by Wall Street firms.

Now look at this chart:

Note very carefully when the home price index went over 150.

Late 2003/2004.

Why is this important?

Because 150 is the maximum level that the home price index had obtained during all of the previous "housing booms" since WWII.

Here is the simple, raw, unadulterated and ugly fact:

It is not possible to pump home prices beyond about the 150 level on that index without intentionally increasing leverage and reducing supervision of lending beyond safe levels.

The actions of every one of the government participants since the housing bubble popped have been focused in one and only one place - obfuscating this simple fact and trying desperately to avoid being held responsible for both their actions and the outcome on the American economy.

Isn't the reason for this "need" obvious?

To admit the truth would mean that Henry Paulson would have to immediately resign in disgrace, and George W. Bush would have had to apologize to the American Public.  In addition, it would only be reasonable for Henry Paulson to disgorge his $500 million in personal wealth gained from the bubble, since it was, effectively, "ill-gotten gains."

Both are simply not going to happen.

Not now, not ever.

All of the other issues (the CRA, bribery of Congress, etc) are important - but none of them were the cause of the bubble, and none of them could have led to the bubble, for one simple reason:

You cannot have the price of a capital good expand beyond the earnings capacity of the underlying owner of that good without creating an environment where lending takes place without limits or standards.

That is, so long as sane leverage limits and a requirement that borrowers be reasonably able to pay exist, a bubble of this magnitude cannot occur.

This is math, not politics.

Tonight Cramer was talking about either letting unlimited immigration take place (to buy up all the homes) or literally bulldozing them (aka what FDR did during The Depression to pigs, cows and fields!), and he's threatening to send that to Obama as "his plan."  Back in the 1930s when this was done it cost thousands of farmers literally everything; their crops were destroyed and livestock shot, and they lost their homesteads as their income was cut off.

That idiocy, should it be attempted with houses, will guarantee that all middle class and lower Americans will go bankrupt, because your cost of living will double, home prices will remain unaffordable, and your wages will not increase by a nickel.

Think about that folks - take your "mandatory bills" and double them, then tell me what the odds are that you escape bankruptcy.

Leave it to a Wall Street thief to come up with something that would grossly increase the amount of damage that America's middle class sustains - never mind CNBC employing someone promoting a policy that would bankrupt half its viewers.

Cramer needs to be put in the stocks - alongside Paulson Bernanke and Bush.

I want to throw rotten tomatoes.

But back to the underlying theme of this entry.....

The mathematical reality of how we got here places in stark relief what must be done to get out of this mess:

1. Leverage limits of 12:1 must be placed on all financial institutions.  No exceptions and no games.  If we cap leverage we cap systemically-important bubbles and prevent them from forming.
2. Ability to pay at the fully indexed rate, inclusive of any potential penalty must be "the essence" of any loan agreement for both consumer and business loans.  This includes credit card "penalty" rates, mortgages and all other forms of debt.  Evidence of this computation being done and within safe and sound limits must be prepared and maintained with all loans.
3. It is already illegal to lie on a loan application.  Falsification of loan applications must be aggressively prosecuted.

Do these three things, prices immediately contract to affordable levels on all things bought with credit, leverage is reduced to affordable levels and debt taken on can be repaid.

This will not prevent the pain that is currently in our economy from being manifest, nor will it "magically fix things." 

But it will contract house prices to where you can afford to actually own your home, it will force credit card issuers to reign in either limits or penalty rates (and perhaps both) and it will arrest future bubbles of systemic significance before they can do critical damage to the financial system.

President Obama's First Legislative Initiative

 My recommendation: Repeal the "Bankruptcy Reform Act."

 Senator Obama voted "Nay".

 Send up a bill to repeal that act.  I bet Congress would pass it and both Nancy Pelosi and Harry Reid would be for it, as it goes directly to "helping the little guy."  Sign it.

 This instantaneously shoves all the bad debt written by the imprudent bankers back where it belongs, while at the same time not letting imprudent borrowers off the hook (going bankrupt isn't painless by any means!)

 Market discipline is a wonderful thing, and this would go a long way toward restoring it.

 I strongly recommend that President Obama do so 20 minutes after being sworn in as President, and tell the American People right here that he will do so as part of his "First 100 Days" initiatives.

 What 'ya say Mr. President?

 Douglas Middleton

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And so it begins... and ends...

"Oct. 28 (Bloomberg) -- Korea Development Bank was approved by the Federal Reserve to sell as much as $830 million of commercial paper to the U.S. central bank."

That's right - our Federal Reserve is no longer backstopping just our stuff, nor even "arranging swaplines" - now we're buying foreign commercial paper issued by a foreign bank controlled by a sovereign!

Jesus.

Yeah, I know that the South Koreans are our friends. So what?

Exactly how far does our printing of Treasuries go?

Now we're printing up Treasuries (taking on debt as America) to be able to buy up foreign bank commercial paper?
I've seen stupid before. This is beyond stupid. Significantly so.

We're not only crowding out our own commercial and private lending (if you haven't noticed mortgage rates continue to rise for this very reason) now we're taking down foreign debt, issuing Treasuries to provide the cash with which to buy foreign commercial paper issued not by a US company, but by a foreign development bank controlled by a foreign government!

Folks, this is outrageous.
Your government's ability to fund its operating debt through taxing you has now been co-opted by The Federal Reserve without a vote and without affirmation of Congress to prop up foreign banking interests.
When we provide foreign aid to a nation Congress appropriates the money and approves of the uses to which it will be put.
This is a blatant open-handed purchase of foreign debt obligating the US taxpayer to pay through his or her taxes the interest on the treasuries issued to cover that buy - without a vote of Congress.

That's bad enough.

What's worse is that our "crowding out" is now extending to foreign banking interests.

Down this rabbit hole lies a dislocation in currency and bond markets.

Ben Bernanke is going to cause a Global Depression.

In fact, he may already have gone too far down the rabbit hole to prevent it from happening.

By the way, to those in Congress who might be reading this, you may wish to note that Ben has committed four of his five "how do I stop a deflation" ideas already - and has failed to stop the deflation. The four are, in short:

1. Buy assets (Bear Stearns debt, et.al.)
2. Low fixed-term loans (e.g. TAF, TSLF, etc)
3. Acquire real or financial assets (TARP anyone?)
4. Treasury issues debt which the Fed then purchases with newly-minted money (Fed Balance sheet doubling anyone?)
5. Announcing an explicit ceiling on long-maturity Treasury debt.

Why is this last one important? Because all of this coupon printing (Treasuries) along with 1-4 is extraordinarily inflationary. I know, Ben said its not in his Congressional testimony. He's lying. It is. You doubt that? Go look at the price of 30 year mortgage money and what has happened to it in recent weeks. Longer-term debt is very sensitive to potential future inflation and will turn upward long before the inflation actually appears, because the lender is stuck with the note for the entire period.

So how do you stop long maturity Treasuries from shooting the moon on yield?

You announce that you are capping the yield through unlimited purchases of same.

That is, you'll buy as many as you need (printing as many dollars as necessary) to hold the price high and yield low.

There is one problem with this - it is insanely inflationary, especially when the government is running a fiscal deficit.

In fact it virtually guarantees a "feedback" cycle that ultimately will destroy both the government and the monetary system.

Here's why.

We currently require about $2 billion a day in foreign flow of funds into our Treasuries to fund our government's operation. We have "gotten away with this" and "enjoyed" unreasonably low yields on long maturity government debt because we buy a lot of foreign things - most specifically Chinese toys and oil. As we do so these governments become awash in dollars - effectively, we are exporting our (monetary) inflation to them in return for their imported goods. To prevent this inflation from destroying their economy they "sterilize" these dollars by buying Treasury securities with them, thereby removing the dollars from circulation and dampening the inflationary impact.

But if Bernanke were to try to cap long yields foreign investors would immediately tender their bonds into The Fed, destroying this external funding source.

Why?

Because all those dollars would devalue the currency, and in doing so foreign interests would take an immediate and permanent capital loss on their bonds, as the dollar would be worth fewer of their native currency units than it was prior to the "capping" expedition. To avoid this risk they would both cut off their purchases of future bonds (since the capped coupon would not reasonably compensate them for the inflationary risk) and tender their present stock, choosing to buy something else (oil, raw materials such as cement, some other government's debt, etc) with their foreign capital flows - something that is not subject to being devalued at whim.

This would force The Fed into an untenable position - capping bond yields creates an instantaneous circle jerk, and the requirement for foreign funding makes the implosion both quicker and more violent than it would otherwise be.

Treasury issues bonds into the market (too many for demand) and this depresses the price and jacks yields. To prevent yields from rising Bernanke monetizes them by buying them off the market to hold up prices and suppress yields, issuing dollars into the market in the process. This causes the total number of dollars in the system to rise (he must print the dollars with which to buy the Treasuries, and give that dollar to someone - either a holder or Treasury which presumably will spend it into the economy), which depresses the foreign trade value of a dollar. Prices for goods (imports especially!) rise precipitously, and holders of these bonds who can't tender them to The Fed sell them, mandating yet more Fed purchases and money printing to keep up the charade.

The inflationary impact of the dollar issuance reduces discretionary spending which in turn reduces real GDP and tax receipts.

That, in turn, forces Treasury to issue more debt to fund operations which......

See the problem? This cycle immediately spirals out of control, leading to a Weimar Germany-type meltdown of the currency and Treasury funding path.

Down this road lies the destruction of America's political and monetary systems.

This is the problem with academics running their "theories" in the real world. In the real world Ben has discovered that his much-vaunted "liquidity pumping" leads to commodity price moon-shots, massive distortions in the corporate debt markets and rising (not falling!) mortgage rates.

Ben's thesis says that none of these "side effects" should have happened, but of course the historical record says that they all did, because in the real world your sphere of influence doesn't extend to people beyond your borders or those whom you cannot compel to do your bidding, all of whom are free to act as they see fit.

You've been warned Congress - Ben's "next trick", and the last of the five, is the one that can destroy this nation's political and monetary system.

PS: I've been right about the impact of Ben's previous machinations - all things he denied would happen but I said would in fact did. Who 'ya wanna place your next - and possibly final - bet with?

The value of all assets must be allowed, even encouraged, to normalize. This crazy attempt to prevent that from happening at all costs will not work and puts our nation's political and monetary systems at risk.

Rick Santelli this morning on CNBC laid it out in nice, clear succinct language - all we have been doing is for one purpose - to protect insolvent, that is bankrupt companies from having to come clean and face the music of the market.

The bad news is that in doing so we have destroyed our credit markets, replacing them with The Fed as the first, last and only lender, and we are threatening to destroy not only the entirety of our capital markets but our monetary and political system as well.

Douglas Middleton [Read More!]

The joke of the day comes from the AP and MSNBC:

"WASHINGTON - An impatient White House is serving notice on banks receiving billions of dollars in federal help to quit hoarding the money and start making more loans."

Oh really?

Let's see.

---

Your Treasury Secretary (you know, a guy you appointed and can fire?) put together the TARP/EESA bill, a three-page document that gave him plenary authority to do whatever the hell he wanted with the $700 billion.

You and he then made a half-dozen appearances on national television for the express purpose of twisting the arms of Congress so as to force it to pass over the strong objections of the American people.

Congress was told that if they attempted to restrict the use of the funds you would veto the bill.

We the people, in our phone calls, letters and faxes both to you and to Congress, said that we disapproved - that Hank Paulson would abuse this power and the banks would abuse our (not your) money.

Paulson in fact did exactly that.

He gave out $125 billion of that money in the form of "equity injections" to these banks without requiring in the form of contact that:
* They not pay out any of it in bonuses, dividends, or executive compensation.
* That they not use it to acquire other companies.
* That they agree to verifiable means of showing that they have used it to make loans into the economy.

The banks in fact are using the money for bonuses and acquisitions, and aren't making loans - exactly as we the people said would happen, and which your political appointee enabled through his explicit actions.

Oh, and speaking of those contracts, where are they? Government in the sunshine? Yeah, right - this is why the two contracts we have seen for services contracted had the pay sections blacked out.

What's even better is this tidbit:

"Indeed, the government approved PNC Financial Services Group Inc. to receive $7.7 billion in return for company stock and, at the same time, PNC said it was acquiring National City Corp. for $5.58 billion."

Got that? Treasury approved $7.7 billion for PNC knowing full well they were going to use nearly all of it to acquire National City, another bank (that is, a competitor.)

In other words we now have proof that Treasury is doling out money knowing full well it won't be used for lending.

And who does Hank Paulson work for Mr. President?

That would be you. He is a direct report.

President Bush, you're embarrassing yourself, The Republican Party, The White House and The United States of America.

The way you express disapproval with what has happened is to summarily fire your stooge Hank Paulson who has intentionally violated what you claim is the purpose for that $700 billion dollars in taxpayer funds - on national television.

This is what you do if your pique is real and not some sort of gaudy show for the American Public and press, praying that the public won't take out the fact that $70 billion of the bailout money was siphoned off into bonuses on Republicans in another week at the voting booth (good luck with that, by the way, given the market's reaction to your idiocy. Speaking of which, that's a very nice stock market crash Paulson and Bernanke caused with the passage of the EESA, no?)

But instead of doing what any executive does when his or her subordinate screws up to such a colossal degree, blowing $700 billion of the firm's (in this case, the taxpayers) money on what amount to beer and hookers, you instead show up in the press to "chastise" the banks and urge that they do that which your stooge did not require (but could have) and in fact which Treasury has said they did not include in their demands because it would limit participation in the program.

In other words, that these banks are not lending the money was no accident.

Henry Paulson omitted these terms knowing full well the banks would not lend and you have full knowledge of this fact - and that's just from what Treasury has said in public!

Your Treasury Secretary shoveled taxpayer money at banks so they could pay out $70 billion in bonuses and make acquisitions, he did so with full knowledge that this was going to happen, and he still has his job that he holds at your pleasure.

Douglas Middleton [Read More!]