The (new) Financial Tsunami thread

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Because you know you wanted to see it again... ;)
The information contained in this thread was too important to be thrown into a "delete bin" by corporate interests.
Due to file constraints, this subject matter will need to be presented in sections.


"The Thinking of Old and Gray",
"The Root of the Financial Tsunami and a Solution",
from the soon defunct MSN Money Talk board



Section One


From the beginning:
Post 1)

For those new to this thread, I believe this PBS Video in regard to the unregulated OTC Derivatives Market and the one person who tried unsuccessfully to regulate it, Brooksley Born, was shut down by the folks from the same school as those currently calling the shots. This video sets the stage for the detailed analysis and opinion that follows: The Warning - Brooksley Born an American Hero :
www.pbs.org/wgbh/pages/frontline/warning/view/?utm_campaign=viewpage&utm_medium=grid&utm_source=grid

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Post 2)
Confronting economic situations requiring in depth discussion, always prompts me to first recall Hayek's claim that economic systems "evolved". Whence came the seed, I don't recall his mentioning. After the system is operating, reason comes onto the scene to explain it. According to the gospel of Hayek, Reason or rational plans are not the cause or instrument of economic development. He spent a great deal of time refining that view in "The Fatal Conceit". One of the titles for a sub section is "Mind is not a Guide but a Product of Cultural Evolution, and Is Based More on Imitation than on Insight or Reason". That's in his Chapter entitled, "Between Instinct and Reason". Heavy thinker, Hayek. I think his life spanned from 1899 into the 1990s. He must have been aware of pretty much not only what I experienced but a lot more before I started to breathe.
I won't try any such reasoning of my own. I think there are two kinds of people when it comes down to developing institutions: those who flesh out the basics, sometimes going so far as to see it installed and operating; and, the followers, intent on finding the systems weak points and putting them to use to their advantage. It's precisely this motivation that moved the army of opportunists to "play" the system for all it was worth and left the ruins for us to pay for and salvage, if it was or is salvageable.
It took a good number of years and the effort of several generations of people to develop the functioning model of our economy. Lots of modification to our "evolving" system. But, what we had even just fifty years ago wouldn't have worked in today's business climate. Still, the "state of denial" bankers and people dealing with banks exhibit is surprising. On the bankers' part, it's probably more acting to keep the public from knowing just what is going on inside the banks. They behave as though nothing has been changed in the past hundred years and beneath the hood is a modern whizzing technological, high powered marvel. That opens the door for those who would "play" the system for their own advantage and closes it to prying eyes. They've gone through all that and left the wreckage behind after they finished playing. In other words, regulations haven't kept pace with technological development.

What lent itself to the partying was the fiduciary media, which began as a credit function and then players learned how to abuse it. The system has been in active development since before Adam Smith and Ricardo, they both wrote of it back in the eighteen and nineteenth centuries. Since nothing springs from the head of Zeus, it was a banking tool used in Italy before that.

Fiduciary media was meant to be a substitute for money, Banks have only two basic true banking functions, to make loans backed by other people's money, and to make loans not supported by anyone's money! The first is almost a cash transaction; the only thing that distinguishes it from a straight cash transaction is a present good is being advanced in return for a future good plus a margin of profit which gives it economic character. But, fiduciary media is more complicated and needs the cooperation of the government, the other issuer of fiduciary media. Both of these banking functions are credit mechanisms, but the first, since it is backed by money, has more value than the second insofar as it is a more readily marketable item.

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Post 3)
Actually, the second has also been marketed, but it's value is a matter of stretching faith. It's only recently that we've discarded the distinction between the two for profit's sake and the trade generated has grown to the point where it's caused problems.Banking has undergone a long, slow gestation period and to my way of thinking is still not mature. We have a way to go before catching up to the manipulators. Four items which were instrumental in encouraging the departure from strictly cash transactions were: (1) the clearing house concept, which was around for quite a long time before it was refined during the nineteenth century (on into the twentieth century) into a more smoothly operating mechanism; (2) liberating money from ties to gold which has been an on and off again practice; (3) fiat currency which you understand; and, (4) ever-widening use of "no-money-loans" and credit. The one thing they all have in common is reducing, if not eliminating, the demand for money.

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Post 4)
Clearinghouses gather together transactions, payments and outlays at the "end of the day" and match the offsets, cancels them out, and makes one payment to whoever has the surplus (the prevailing balance). These are the claims and counterclaims. In the US, the Federal Reserve Banks perform this function. In the process of settling offsets by cancellation, there is less demand for money. The cancellation takes the place of tediously and slowly moving vast amounts of money through the business and banking arena. It speeds the transaction to the consummation, and requires no money at all. Hence, the claim to fiduciary media.
While our money was actual gold, gold certificates, or tied to a gold standard, limits on the flexibility of currency prevented the "players" from manipulating the system. Gold was expensive, cumbersome, difficult to hide or manipulative in large markets. So, the flim flam artists were restricted to small areas, not enough to bring down an entire nation should things go wrong. On the occasions when currency was freed from the tie to gold and the stability it provided, we suffered. The 1830's with the National Bank, the 1870s after the greenbacks of the Civil War (along with others) were desperate times.
The same was true in the twentieth century during WWI and WWII, the depression, and the problems we encountered after going off the gold standard in the early 1970s. In each occasion, speculation within the banks was an issue as they turned to more dalliance with fiduciary media. The games ensued, and we ended up paying a price for the wildness. Obviously, when currency is released from ties to something with a stable value, markets have a problem deciding just where the currency belongs and banks decided to simply take advantage of the opportunity and to the devil with the consequence, which were predictable.
Smaller nations with weak currencies attempt to tie their money to the stronger media of a larger country, providing it is close enough and there are cultural similarities. Mundell was addressing that issue with Friedman in the dialog you read, and made his reputation on his "optimum currency area" studies, which is the tie between the currencies of two or more countries. All the weaker country need do is convince their creditors that since there is a tie between their weaker currency and the stronger currency, it is as good as the real thing. In a very real sense, it is a simulation of fiduciary media. That weak currency will not stand on its own in the world market.
An even more direct resort to fiduciary media results when the smaller country then allows its central banks to begin issuing credit first tied to its own currency, then tied to nothing. Which has happened in South America and in Asiatic countries within the past twenty years. The panic sets in when their creditors ask for currency they consider more substantial and there's none to be found in the vault. Ask yourself what would happen to the US if we found ourself in that situation. If the fiduciary media is contained within the bounds of the nation it may or may not harm only that nation, depending on whether the public is willing to accept and continue working with the situation.. Once it passes the borders into the global markets, creditors look for satisfaction. In short, those nations were in trouble because they had nothing but fiduciary media. They didn't have a situation where the demand for money was lessened, they had no money!

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Post 5) sentence finished

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Post 6 and 7 )
A nation under fiat currency rule is the perfect setting for fiduciary media. As we developed through the nineteenth century, each time the "players" found an opening, they began the game. When it became evident what was transpiring, that our system was being undermined, the government changed its stance and reinstated a standard. Since 1971, we've been struggling to find a durable standard and really have been unsuccessful to this point. Periodically, we readjust and go back to the same game. And, the next occasion proves to be a little more severe than the previous. One of these occasions, we'll be unable to recover.So, precisely how are banks effecting our system when they produce fiduciary media?
Can you imagine how much credit is being generated in normal times, when all commercial banks need do to extend a loan is open another current account and declare the account fully funded? And, they can do the same for themselves to invest or acquire? What does make it so much easier and quicker today are electronic transfers, electronic transactions. A bank can open an account, fund it, transfer the money and purchase something in Europe or Asia and the entire transaction can be completed with unbelievable dispatch, the speed of electricity. No money has changed hands, there was neither demand for nor delivery of money.
At this point, I'd mention that once you reduce the demand for money, you're reducing if not eliminating the importance of volume and velocity. That means, if this is so, all the economic formulae that use not only these two factors as essential elements in their explanations, but other measures of money or the character of money, or the flaws or traceability of money are obsolete and treading on suspect ground. The money we knew is no longer the money of convenience. All the attributes we looked for in money, the elasticity, the volume fluctuation, and velocity are concerns of the past. We have a new money. What do we use that is not fiduciary money now? Charge cards, debit cards, checks, loans, funded accounts, buy a car, a house, a refrigerator, have your kitchen or bath redone. . . not a piece of money changes hands at any step of the process. Money is obsolete!
Banks could not care less about no longer having a vault full of money. Other than to accommodate clients who experience a sensation of safety with the warm press of money in their pocket, banks have no need for currency. It's a clutter they tolerate. What this technique has caused is concern that bankers will have to confess what they've been up to. They should have no fear. No one will understand the explanation. The only problem might be, if they did understand, depositors probably won't like it.
There has been no inventory taken of money for years. M3 has been discontinued, M1 and M2 are approximations, and the last released figures they've compiled on the total amount of US money in the world are indefinite in both distribution and location. That's only because they do not care. The banks are generating money accounts out of thin air faster than it can be counted and distributing it to the far reaches of the globe beyond the government's capacity to trace. All of this under the cooperation of the legislature that passed the Gramm-Leach-Bliley (1999) which promised not to look into the game with the derivatives, and the Financial Institutions Reform Act in 1987(?) which allowed them to make all kinds of alliances.

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Post 8)
Talk about a new paradigm. The old regulations do not work if it takes a regulator two hours to get to the locus of a loan or purchase origin and a transaction can be accomplished in much less than a half an hour. How long will it take a regulator to catch up on a day's bank work? And what do they do after the fact? When the transaction involves three or four parties and extends even further by the time the regulator catches up to the last party listed as holder of record, and that party has already sold the rights, what then? We need a complete overhaul of the standards of bank regulation. And no one in Washington is capable of handling this assignment. They have taken this beyond the limits of regulations' imagination or ability to cope. It's moved so fast, the banks themselves don't know what they've done.
This can be addressed only if economists devote themselves to the analysis of the situation and sufficient numbers with enough weight discuss the matter openly with an urgency that's undeniable and which demands responsive action.

We've been addressing the issue of derivatives. How did the banks get so much and why it is off the balance sheet as a memorandum? Does it seem any clearer now that fiduciary media has been discussed and the parameters addressed? Since the funds were created out of thin air, should it be a matter of concern? They took on the responsibility of being guarantor of a certain percentage of these. That's a contract! Banks may be called on to perform, to guarantee the loss sustained when the market value is finally established. I'm sure the folks who purchased the contracts won't accept fiduciary media for settlement.

This is the kind of play that entices the speculators in regard to fiduciary media. Certainly, it's a tool. Derivatives is a tool. But, the question is simply what happens when you misapply or misuse tools? Someone eventually gets hurt. Do we want to bail these people out?

Remember, the ten largest domestic banks own 100% of that $183 trillion dollars nominal value of the derivatives.

But, I've strayed from the rest of the issue I started out on, haven't I? That comes next.

After I posted the 5 parter above, I was ruminating through this morning and the irony struck me, that the observation noting the global financial community is confronted with a new currency whose technology has not yet been addressed by the economic theorists has been advanced by a man just a couple of months short of 88 years of age. That's an unexpected anomaly! But, then, if the visions can't be expressed by someone not facing repercussions, then by whom?

Truth is, it was a subject three of us tried to address back in the late sixties. We met nothing but detractors. Undaunted, we proceeded to the end and had the book published. No publisher in the US would touch it. In the economics literary field, peer review is essential and the two super geniuses I managed to latch onto were so far out ahead of orthodoxy, ridicule was a gentle characterizationof the reception granted to us.

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Post 9)
It was eventually published. . . in Japan! And, though the publisher tried to distribute it globally, there was limited interest. Fortunately, the right kind of people had the interest. I'm certain we three weren't the only people intrigued by the potential in electronics and banking but tothat point we knew of no others. So for one thing, we felt like pioneers. For another, each of us ended up with a smattering of reputation and it provided a springboard for satisfying careers. The other two were younger than I and are still active.

So, I've been nurturing these thoughts about new currency for a long time. The exposition above is glossing over some of the more detailed points for the sake of brevity and a less distracting presentation. I have expressed some of my more recent thinking. To my two friends, if you read this, indulge me please, s'il vouz plais.

During this morning, the thought also occurred to mention that banks, currency, trade and the entire world economy is under constant strain. There's a number of reasons for this, but a short summarization is based on one simple continuous process, uneven change. Whenever change presents itself, adaptation is necessary to deal with previously unencountered scenarios. And, when you have a system that encompasses the entire commercial world as our world wide banking system does, the revisions needed don't come easily. We can no longer treat changes as a local phenomena and what's good for one nation may not necessarily apply to another. There are a number of well-respected bankers and economists who lay out all manner of possibilities for coping with new developments and the problems they generate. And, then they exempt one country from the rest of the world with the caveat, "but this does not apply to the United States". In the near past we've enjoyed a position of eminence few did other than England prior to the Great Depression. When England had the distinction, every economy would think what was best for them and the last thing they'd ask, "But what would England think (or do)"?

There's a never ending, virulent string of situations threatening world financial stability. By one means or another we find our way out of each one of them. If you'd try to investigate all that's been dissected, analyzed and prognosticated, you'd find how impossible that would be. There's not enough time in a lifetime to handle that. So, often, some compromise or slightly new band aid is applied and we go. Whether the problem is local or world wide, we manage to find a way out. Sometimes it requires oppressive sacrifices like wage and price controls, sometimes it would have to be the more drastic abandoning of the old currency and installing new. The crises controlled through minor local adjustments are hardly worth mentioning except when the undesirable effects are exported.

Whether through superior intellect or exemplary management skills, we always manage to escape the problem and life goes on. The one sustaining character of humans is that they are adaptable, even though they resist adaptation with a flurry of complaints and growls. What they thought was so essential that made life not worth living without, suddenly, with a new set of values forced on them, they discover they can do without! Many of the problems that seem insurmountable are handled by patience. When the inconvenient urgency of a crisis recedes, we resume normal opera

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Post 10 ,11and 12)
When the inconvenient urgency of a crisis recedes, we resume normal operations. So, I believe that personal preference plays a large role in how we perceive crises. My own hope is that ability to analyze and adapt never leaves us. Once we have a view of the situation that makes sense to us, we can then restructure and restart our institutions, which may not be recognizable in the reincarnation, but (guaranteed!) it will function in the manner we require.So, I believe that personal preference plays a large role in how we perceive crises. My own hope is that ability to analyze and adapt never leaves us. Once we have a view of the situation that makes sense to us, we can then restructure and restart our institutions, which may not be recognizable in the reincarnation, but (guaranteed!) it will function in the manner we require.

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Post 13)
The problem with Bernanke and the Fed is the majority insists on fighting for deflation which is programmed to represent lender's interest while ignoring the increasing pace of inflation. I know of nothing that is not showing signs of inflationary stress at this time. And, we're fighting deflation? Or, promoting it? We are not fighting inflation!

Oil is down from it's all time peak, but up from it's past levels. Property taxes are climbing, insurance rates are up, utilities are up, food is up drastically, I couldn't comment from personal experience with clothing, although I know that shoes are more expensive. Anything imported is expensive. Take your pick. The threat to the auto industry has caused a little retreat. Airline industry is claiming problems, discount seats are few and difficult to secure, otherwise their prices are up. On top of that, they're cutting back on flights in an attempt to squelch protests about rising prices by providing fewer seats.

Cranking up the credit machine and piling more credit burden onto the other problems in the financial sector, just will not prevent deflation from setting in. But, the first question is why try to deal with it? Anyone who reads any economic theory knows how the majority of economists believe lowering interest rates does not stimulate good business growth! It stimulates bad business choices! What we're ending up with is another squeeze on the going commercial enterprises. Layoffs, cut backs in production, more expensive imports, and greater overall stress on our system.

These are misguided Keynesian choices. I thought he and his theories were dead, but in desperation they're reaching out for any floating sticks on the stormy waters. If they're going to depend on Keynes' life raft, they're making the wrong choice. Keynes never addressed the situation of fluctuating interest rates, never had a solution for any economy beset with problems. His economics was developed and explained as though in a sterile, protected environment. To my way of thinking that's absolutely useless, and yet I still see writers and economists still quoting Keynes.

Stiglitz and Krugman are realists, there are others. . . Mundell (you've read at least a little of his thoughts, I know) among them. I'd even goback to Ricardo, who laid a great of groundwork for pragmatic economics. They should be the people quoted, read and whose theories are put to work.
With the amount of debt disguised as credit that the US needs to peddle on the world market, there's no way they can maintain a respectable level of return for Treasuries. I don't think informed bond investors will be attracted to desperation should the US begin to kite interest rates.

[franktheimpaler]

uh oh!

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Post 14)
There a hysteresis (a lag time) between the dumping on the market and the market's reaction to too many bonds, almost the exact opposite of the stock markets predilection for "discounting". When the realization arrives on the bond market, that there is too much floating credit and not enough buyers, that's when negative interest rates kick in, regardless of how high the issuer boosts rates. At that time, the question is, "So, you offer fifteen percent? . . . and, I collect when? . . if ever?" The response might be, "No, thanks, I think I'll go for the Chinese sure thing for less than half that." And their next buy is wired to Hong Kong. There has already been wide-spread discussion about and investing in Oriental ETFs! Isn't that a compass of some sort?Striving for deflation to protect the lender's interests is as bad a program as allowing minor inflation to grow into hyperinflation through carelessness or inattentiveness. Of course, moderation is called for, but a moderation that leaves us in a position to control what we're using as a weapon and the problem we're fighting. Deflation will certainly end us in a depression. . THAT'S A GIVEN! Inflation can be controlled. But, you must turn your attention to it in order to control it! This we are not doing!

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Post 15)
I see four basic problem areas that need addressing. We need to pay attention to interest rates (to control the swing between inflation and deflation which will need correction as other items are tended to);the flow of credit used as money must be addressed (it's become a pervasive presence, it's obviated the once important role of currency volume and velocity, a fact everyone is ignoring);tax revisions (a means of both restraining the piracy and encouraging systemic redirection to help restore a balanced economy which referred to as equilibrium); and restoring a free flowing lending process to the banking system (first attention must be directed toward cleaning out the detritus in the system, and secondly, reinstate the reporting and regulatory measures removed to accommodate the people who took us down the wrong path). The statement is an over-simplification, but stay with it and we'll make it more complex as we proceed. First thing we must acknowledge is that as we emerge from this mess, we must be aiming at equilibrium and that takes into consideration the segments of our nation's economy in the order of their importance. Since 71% of the GDP services the consumer, restoring consumer confidence and strength should have first consideration in any policy move. Commerce is still 29% of our GDP. That is broken up into production, banking and investment. People are struggling to decide which deserves the major part of the attention. Since banking and investment got us into this mess, they are the sectors most in need of revision and redirection. Restraint first, then correction, then restoration is the process I favor. The immediate and most obvious device, of course, is adjusting interest rates. But, dropping rates to zero coupled with inflation and systemic retraction, has a net effect of a negative rate which only magnifies the debt problems we face and threatens our future. If we get out of today's mess, we won't be able to do much to improve our position tomorrow. Our interest rate policy also does nothing to convey assurances that we can handle the problem. It has the effect more of a desperation or surrender move than a corrective measure. We are in the middle of bad monetary policy where rates are concerned.Dropping rates does not have a corrective impulse to it. It's a defensive posture, no more. And, we need something a little more convincing than defense. That means an almost simultaneous attack in the areas that were instrumental in carrying us to this sorry state. That's the flow of credit used as money which everyone ignores. Usually, the reason people ignore an important issue is due to misunderstanding or not recognizing the existence of issue. I'll try to define the trap we sprung on ourselves as I see it. When this is brought out in the open, we may be better equipped to understand how to restore the free flow of lending on a solid basis. I'll prepare you by saying it's quite an involved analysis on the changing nature of currency which has caused the misconceptions and subsequent abuses that are at the root of our problems.

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Post 16, 17 and 18)
The outcome of the misdirected controls will be the wild swing that MacQueen cites. Interest rates never should have been lowered to zero. My own feeling was that 2% was already too low, and reduction beyond that point was reckless flirting with disaster. The Fe dis fighting the wrong battle, trying to appease folks with the wrong take on our problems.

Over the weekend I caught just a glimpse of a program on PBS where I believe the moderator was Roubini. His panel was composed of international experts, Japanese, European, and the little I caught had the moderator asking some pretty penetrating questions based on experiences of their home countries battle against situations similar to those we face. It was disappointing to listen to the diplomatic responses, trying hard to address the issue but by no means prepared to respond in a way that might embarrass the US. The only conclusion I could draw from the evasion was that we're doing it wrong but the foreigners did not want to say that.
Mssrs. Bernanke and Paulson did not do our defined financial system any favors by allowing banks to expand their activities. Brokers and insurance companies were brought into the corporate fold and, as a result banks' role and functions have been muddled and their character changed just as the fiduciary credit explosion changed the nature of money. Now we need a new set of regulations and definitions.
The old regulations, which separated banks into the commercial, savings, S&Ls and credit union categories, had control and supervision procedures for each of them. Many commercial banks are no longer strictly commercial banks. Which of the old regulations apply to them? Have they commingled accounts? Investments are handled differently by banks, brokers and the insurance industry. If the Fed or FDIC regulators show up, is a bank justified in complaining that whatever violation is cited does not apply since that is no longer a banking function, etc., etc.?Obviously not only are the legislators and the regulating agencies now obligated to put their heads together and try to regulate the abuses that brought us to this state, but they'll need to address a bucketful of previously unnecessary and undefined issues.
Some of the old regulations would still apply, but the workplace for regulators has definitely shifted toward much more complexity.
The muddied role the Fed created for itself needs to be addressed. If the Fed's present arrangement is to be permanent, it will have to be carefully drawn up, delineated and determined which of the Fed's new powers should be regulated and by whom. I believe they forfeited the right to act independent of oversight. This certainly should be addressed through legislation. It certainly is not covered by the existing Fed Reserve Act of 1913! They had no idea the Fed would take the extraordinary steps they did. So, redefining the Fed is a major issue if not the primary issue.
Acknowledging what commercial banks have done with their gratuitous issuing of credit, points out the need for revising accounting practices and standards and bringing total transparency to their operations. There should be no more $183 trillion dollars in the memoranda!

Of great importance in untangling the new bank roles will be reconsideration of old regulations and establishing new codes.

Since we've contaminated the world's financial systems, coordinating with the international banking system is of great importance, and while this is being done, consideration of other country's laws and MOs are a necessity.

And throughout this entire process, (I can't overstress my concern for this): the consumer's interests should be protected. Banks have been extremely aggressive in levying exorbitant fees to cover the losses incurred through their profitless half-illegal activities. The consumer should not have a dual role in the recovery as a taxpayer funding the bailouts and as a consumer being waylaid to pay for bank mismanagement indiscretions with even higher fees.
You do have the four basic things I believe must be recognized and confronted in order to correct the ailing economy. They're so interactive that one or two of them alone is drastically inadequate. One thought I've always borne, there's more than one way to approach a resolution of any problem. However, there's seldom more than one problem, no matter how massive or complex the issue. The trick is first to see it, then attack it.Bernanke's path is confusing. I think that's why Rupert may be ignoring Bernanke's path. Rupert may believe that it isn't possible that a Princeton professor of economics could be so far astray of the more appropriate path as Bernanke is.

Bernanke's fighting the battle that doesn't need fighting and has been doing so for at least eighteen months now, following the lead of Paulson, who was ill-prepared for the position he had. As long as things were being neglected, the tandem were well prepared for the seats they occupied. When action was needed, we discovered just how unrealistic their views and plans were.

Bernanke's had this program in his head for more than ten years, anxious to put it to use. He couldn't wait for the proper occasion so he jumped on the first one that came along and swung into action. Never mind that the situation doesn't fit his own description of the problem he was prepared to address. Apparently, that is of no consequence to him. I've got a solution where's a problem, is more likely his approach.

I agree with Mark MacQueen, and you're probably aware of my opposition to the Fed's current policy precisely on the grounds that we are headed in the wrong direction, trying to manipulate something that responds least to control when it is not our principle problem.

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Post 19)
How do you treat the developed mess so confusing it can't be recognized or defined with existing standards and regulations? The Paulson/Bernanke dynamic duo created Frankenstein banking that has every opportunity to avoid any regulation now on the books. They've been trying for eighty years to restore the uncontrolled engagements they enjoyed before they drove us into the Great Depression. They've finally succeeded. I posted comments to this effect last year soon after I first joined these boards. Now they have it all: free banking, like free love without the ties that bind. No responsibility, no accountability! I challenge any regulator to enter the institution that now has a totally new identity and describe what kind of institution he's examining and whether all the accounts are where they belong. He simply does not know! Banks are without regulation or oversight.Have you noticed the euphoria on the markets? Banks stocks are up. Not the first step has been taken to clean up the banking mess and their stock is rising. . all in anticipation of the carnival they intend to run now that they've untangled the leash and freed themselves from it. What we need to control banks and in what time frame it will be adopted are from two different worlds. Redefining and reassigning delineations of the complex entities Bernanke et cie have created is a project of monstrous proportions which will suffer endless wrangling and bitter confrontations. This is something the economy can't tolerate. Wednesday, Volcker, appearing before the Senate Banking Committee, testified that between the time the concept of Basel I was introduced until it was in effect, required two years. Basel II required considerably longer. That was a matter of setting standards for a banking system that was in place, regulated, defined and receptive to the ideas and practices enumerated by Basel I. We have a thorny issue in the confrontational executives who eschew controls and regulations, managing massive entities not encountered during current regulators' lives. They would categorically oppose any redefining of their new character. I believe they will resist with vehement objection the imposition of any further regulations dealing with more examinations, delineations, restrictions or constraints no matter how much they're proved to be needed. Not for principles sake! Underneath it all, they don't want anyone to discover just how they are conducting business, or what their business really consists of.The ideal situation would be to have a benevolent czar, fully versed in banking , economics, regulations and world-wide financial community service to assume a super-dominant role and arbitrarily issue commands to steer the domestic financial system in the proper direction.That won't happen, and I wouldn't trust any one soul with the responsibility and power, so I won't advocate such. On the other hand, a few more crises of the severity of this one or worse and we may end up with one.So what's the next best thing? Let the market sort it out? Government support through a string of never-ending bailouts is not the proper approach. Supporting the weak links only blows a few lungfuls of air into the same corpse that infected us last time, so it can rise, reel drunkenly through the community, spread more toxicity and then collapse again.

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Post 20 )
re: the Swiss method

Nationalizing is not the answer to our problem. We have a different behavior pattern not suited to Swiss subtlety.

The Swiss are too cultured to deal effectively with what resulted from our wild spree. Nationalizing, no matter how temporary, is no more than renaming the bailout. In the end, the taxpayer bears the brunt of the burden and the robber barons live to ride again. Our judicial system has a previously developed answer for precisely this kind of situation, and we do have the mechanism in place. If the executives do not have the talent to guide a company judiciously and steers it onto the rocks, a corporation either dissolves or enters bankruptcy. The executives hate either of these two options because they both scream of MIS-MANAGEMENT! But how is nationalization any different? Can everyone hear the boasting in the clubhouse? "We're not bankrupt, we're nationalized!" A name change, nothing more. And, it's to be regulated by whom? No doubt someone like Kashkari, unschooled and unprepared.

Bankruptcy does the community as well as the shareholder a service. It displaces the inept, scheming management with a receiver, hopefully competent or at the least more competent and honest than the thieves they replace. At any rate, the receivers are subject to court oversight. The current bunch enjoys the limitless horizons of no accountability and unfettered irresponsibility while screaming the government should keep hands off once they've delivered the Care packages. At the annual meetings, shareholders rubber stamp the nominees who have already been cleared by the incumbents so no friction results and business continues as usual.

With this picture in mind, and acknowledging that the Fed and Treasury are responsible for creating this unknown, untamed monster, the first necessity would be to put the Fed under new constraints so they cannot create another scenario which might either duplicate this mess or create one even worse. The "oversight" it currently is subject to, is truly a non-event. To appear before gullible legislators and deliver a speech which no one is prepared to examine in detail (mostly because it consists of smoke) is not oversight. I doubt seriously that the Fed has ever been called on to explain their actions, desist from any activity, alter any practice, or introduce any new policy during any "oversight" session. It's a pre-arranged drama that passes the time of day and helps the public in no way.
Post 21)
Here are some considerations I believe are important.

The Fed, since they are closest to daily contact of banking activity, should assume the responsibility of regulating and supervising credit expansion so as to prevent the reoccurrence of the derivatives scam as well as control the nature and extension of leveraged money and credit. These will-of-the-wisp investment instruments will be back again with another name and should be guarded against. It paid off well for the insiders and they do not intend to relinquish that advantage. This would be in line with the Fed's legislated charge of promoting stability and assisting in the implementation of monetary policy. Monetary policy cannot be controlled without strict oversight of rogue investment instruments. Since the soundness of banks is basic for soundness of the nation's economy, much stricter compliance to more stringent rules are a necessity. The Fed under the past two Chairmen has proved its inability to contribute to our national stability. This would be a day to day, year around duty of the Fed.

I might even consider moving all regulating agencies into the Fed to guard against the flaw of regulators not talking to regulators meaning overlooked or missed assignments resulting in disastrous regulatory missteps. Also, this would provide the Fed with a trained staff at start up and avoid duplication of effort. The Fed clearinghouse is a good place to initiate this activity.

Derivatives being the problem they are, The Fed should see to it that it doesn't occur again. It should have the regulating authority to intercept all banking high-risk-questionable-gain activities. Again, the Fed's clearinghouse is an appropriate venue for such control. It would go hand in hand with their ability to track unusual demands for, or transference of, funds. With today's computerized activities, it should be a simple matter to detect unusual occurrences. If the system has the capabilities of tracking private individuals trying to negotiate a cash transaction of $10,000 or more, it's no greater problem to monitor bank activity of a suspicious nature. A beep, a red flag, and the investigating team is on its way!

I'd change the conditions under which banks are allowed to issue credit almost at will or indiscriminately. Liquidity would be under constant surveillance. That means that fiduciary credit could become a reportable, traceable function of credit subject to monitoring. We might even include a mandatory separate entry in the balance sheet to detail any such activity. This will be mentioned later when we deal with the accounting aspect.

All this means more control of, and intrusion into banking activity. They earned it and shouldn't complain, but they will. As I witnessed it through the years, they've already proved, on numerous occasions that they have an unerring tendency to go beyond limits of what is considered ethical or at the least prudent banking practices.

There are times when we need a quick response to unforeseen circumstances. Allowance can be provided for this. Not unilaterally, but through a system of controls which need to be established so that dialog between the Fed and the banks would determine when it is advisable to proceed into practices not normal to daily activity. The order should originate from the Fed within the limits of its authority.
Post 22)
That's what I would like to see change in the Fed's role. Again, above all, the Fed must be under the direct supervision of an elevated body of officials, preferably elected and subject to recall, responsible for representing the nation's entire, varied interests.
Post 23)
Well, do you believe that tax payers should pay some arbitrary value for all the toxic assets, without reference to any market value bench mark?

There is a way of clearing this up without involving the taxpayers or any party innocent of the scheme.

Jan. 30th, on the OTC thread, I posted a reprise of an old economic concept of retiring a claim, namely, when the claim and counterclaim are vested in the same party, there can be no claim. Within a group, exchanges can be settled by transferring within that group until claim and counterclaim are between the same party. The other side of the coin: if the debtor acquires the claim, there is no longer a counterparty.

What this adds up to in essence is. . Let the banks who committed the fraud buy back their fraudulent paper at whatever price the defrauded holder is wiling to settle for. The market is out of it, the taxpayer is off the hook, and somebody who pocketed proceeds is required to put the money back on the table. What happens in court? Restitution is required!

Do they deserve any better?
Does it make sense to bail out these banks through a "Bad Bank" or any other mechanism, when they are clearly insolvent?

I believe we'll be hearing from one banking group or another, or some international group that banks unable to stand on their own should be allowed to collapse and die honorably. What happens to a non-banking corporation when they reach a point, whether through mismanagement or market failure or end-of-product life with no alternative product, they are no longer a viable concern? Why should a single bank be exempt from such a reality? Death is a fact of life!
Can the smaller and intermediate regional banks that have loaned responsibly take over the lending requirements of the giant derivative laden insolvent banks if those banks are allowed to go bankrupt?

Interesting that you should separate out the smaller banks because I had the same intention in my next sequence on the treatment of banks in my scheme for the new definitions and, perhaps, functions of banks. I believe if a group of banks perform in dependable fashion, they're entitled to special consideration. The concept of too-big-to-fail galls me. It sounds too much like an invitation to misbehave. No matter what, all will be forgiven. (BTW, I noticed on the FDIC site that accounts at three more banks have been taken over since Friday.) If the large bank has accounts of a size or nature which cannot be absorbed by other banks, then might be the time for a National bank to take over. If that is the case, require the Federal Reserve Bank System to serve that function until adequate arrangements can be made.

My personal preference is for the solidity of small, local, conservative banks, diversified under proven standards which were established years ago. At one time conservative standards held that banks should not invest more than 10% of their assets in any one entity. That limited growth, but it also limited exposure to excessive risk.

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Post 24)
I recruited one woman for service on a local activity's auditing committee without knowing with which bank she was associated. During a lull in our work, I found out. I asked if the bank wasn't working with a certain contractor. Yes. Weren't they committing a great deal to service that contractor? After hesitation, yes. After a pause, are you interested in seeking out another position. And, she turned red.

The contractor was a gambler and when he collapsed, so did the bank holding nearly 80% of his paper. Fortunately, the woman was working at another bank by that time. She grew to be one of my wife's close friends. We served on that and a few other auditing committees together.

Conservatism in business dealings! There are other older standards which dictate prudent bank behavior. I swear by them and they have served me well.

If banks can't observe common sense, they deserve what results.

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Post 25)
As for their future: I believe that in revised banking regulations there should be a distinction between the way larger banks and the smaller banks are treated. Smaller banks, as we both know, are not likely to create credit out of thin air. They're serving clientele directly in contact with them on a daily basis and basically distrustful of gamblers. It's their money at stake and they're aware of what banks are up to. The more they deposit, the more they'll have access to the top man's inner sanctum, the more they feel entitled to ask, and the more likely they are to know the correct, embarrassing questions. Good bank managers do not like to be embarrassed. So, in this circle we have a natural and effective regulating device.I think this all adds up to entitling the smaller banks to less intrusive, separate treatment. BTW, Have you hugged your local banker today?I'm not in favor of nationalization as explained above because it's simply another name for the same thing. The derivatives are really the responsibility of the banks who spawned the creation and engaged in the deception. Let them deal with it, and put a time limit on the divestiture or suppression. I don't see them as complex in nature. Just write the sequence down and see how few steps there are to the creation and dispersal and awarding the fees. I do see an anxious brace of bankers willing to confuse the issue and pretend derivatives are too big to handle. It still should be their problem or their demise. I still remember the North Carolina banker who spent twenty years paying back those who lost money during the '29 bust so that not a depositor lost a cent! That's responsible banking. That's integrity. Is there no more recognition of the attribute? And, he had a lovely daughter.

Oversight and revised regulations to eliminate the impulsive or addictive generation of derivatives, is the answer to controlling them. I don't know whether derivatives of the same weak nature are still being written. It's impossible to tell that from the current FDIC SDIs. Derivatives are down to $177 trillion, but fewer banks are responding in the September 30, 2008 report. (About a 100 less.) There's no indication of which banks they might be, holders or not.

[comokate]

Post 26)
To continue on the distinction between larger and smaller banks, since all $183 trillion of the domestic toxic derivatives (and who knows how much of the exported remainder) are housed in the 10 or 12 largest banks, and if you assume as I do, that the toxic paper was generated out of fiduciary media, then the larger institutions have earned the responsibility of submitting to closer scrutiny and stricter controls than the smaller banks not engaged in the self-serving practice. Other reasons for the distinction are listed above.
The big banks should be restricted in the high risk transactions of any kind that deal with these imaginative creations, present or future, and monitored to assure the system and the nation that they comply. Since the mechanism will then be in place, and banks will now be involved in some measure with brokers and investment accounts, further restrictions will result from a more careful definition and delineation of their commingled functions and duties. Lines must be drawn to prevent the banking functions from engaging in the speculative aspect of the brokers, or the investment techniques of the insurance business. There should be no opportunity for banks to use the new conglomerate construct to use brokering regulations or insurance provisions to justify banking practices, or vice versa for that matter.
Insurance in particular is a extremely self-determining, self-regulating industry. The IRS codes usually end up by deferring to "industry" standards or practices, meaning, the IRS accepts whatever interpretation or enunciation the insurance industry puts on their own activity. It's characteristic of the insurance industry to avoid any dissent from clients or customers by using the general referral to "your tax advisor". The end result is that the tax advisor takes the insurance industry interpretation of how distributions are to be taxed or reported since the IRS hasn't a clue as to how it's done. Banks should be denied the opportunity to engage in similar procedures or tactics, even where the new bank-insurance business is in use.
And the investment bank end of the new conglomerate should not enjoy benefits of the banking industries laws. One of the threatening outcomes may very well be that brokerages and investment banks may now be able to use fiduciary media to finance their ownership or control of investment instruments, a dangerous concept, but with the new amalgam, there are now no enforceable prohibitions to prevent it. Hedge funds, private pools, money market funds, these and so much more of brokerage activities, so unlike any business banks previously conducted, will now be under the banks' roof and carefully constructed regulations must address these and other similar conflicts of interest issues.

What happens to the investors in the brokerages and investment banks? Their control of the investment banks should not be carried over to include control of the commercial bank aspect. The Fed has rather strict rules as to whom and by how much banking interests ownership may be held and what governorship can be assumed by the non-banking investors. With the melding of the three units, what is intended for the role of the investors now in place in the assimilated, once independent units?

[comokate]

Post 27)
These and other similar problems are faced by the new construct and are desperately in need of attention before the new combined industry has an opportunity to begin branching out into areas hitherto denied to banks, insurance or investment enterprises.

As large as it seems, this is only the beginning rather than the goal of the new regulations required. There's a lot of work in the aspect of defining and regulating what the Fed hath wrought. This is probably central to the thinking of Volcker, when, several months ago in the interview with Charlie Rose he intimated that the Fed's actions In Re Bear Stearns was opening a can of worms (not in those words, of course).
Post 28)
Above all, we must make the distinction between the use of normal banking techniques in normal banking operation and trying to utilize those very special techniques (such as generating fiduciary media) for non-banking purposes. That's where the corruption appears and the undermining of the financial system originates. Those who cannot resist the temptation should be drummed out of the business. If a judge can rule that Frank Lorenzo is not fit to run an airline, why should a judge not rule that so and so has proven himself not fit to run a bank?
Not mentioned to this point is the activity of the G20 in process and the obvious need to coordinate everything done domestically as it effects the international banking and financial scenes. A system must be set up to allow for close communication on the important issues. I'm sure the foreign banks want input of some kind on whether the new regulations will effect them or not. And, they're probably entitled to it.
I'll leave the concept of new banking definitions and regulations at this point before I begin to generate a 600 page text book.

Next subject should be accounting considerations: transparency, reporting, and the balance sheet, moving the off balance sheet activities back on.



Its' your choice: stop or proceed? I await your word. Have we covered enough? I don't want to overwork my invitation.

As vast (and sensitive) as it is, those working on this subject in locked, windowless rooms are really not leaking very much. Although inquisitive minds may need more sustenance, there's a limit to what we can endure.

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Post 29)
The dictator option is frightening, isn't it? One thing that occurs to me. . . If the moneyed people do not like the corrections proposed, and/or promulgated, they might very well buy their own man on a white horse and try to force their preferences down our gullets. It never starts out that way. It begins with a very reasonable, likeable leader who promises real improvement and works his way in to power, delivers the goods on one item and then takes over and implements the agenda he's been picked to handle. Hitler and Mussolini had backers. All the large conglomerates, cartels and dissatisfied industrialists (especially the Krupp family with their munitions factories) wanted to steer the country away from its growing tendency to lean toward communism. In the twenties and thirties, the communists were quite active for one thing. In the thirties workers world wide were organizing unions and fighting for a better life than the oppressive working conditions allowed. Of course, that got the communist label. So industrialists were anxious to create an environment more to their liking. In the US, we had a couple of men on white horses who were aiming at taking over the government and leading it in the "right" direction. We were lucky we didn't end up with a government like Hitler's Chancellory. Many famous people thought Hitler's way was the right way. Charles Lindberg is reputed to have had a German wife and a German household. The English Economist, John Maynard Keynes believed that Hitler's was was the right way. There were German American Bunds nationwide. Chicago in the thirties, prior to WWII was an American fascist stronghold.

So, the proposal that we might have a strong armed dictator might not be far fetched, but I doubt that it will be a happy ending. It's more likely that the people who gave us the banking crisis to start off the twenty first century will buy the government and give us more of the same with more severe consequences.

Politics is generally the enforcement end of the financiers and bankers policies. At least, that's how they look at it.

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Post 30)
Are you talking about modifying the fractional reserve system or more radically, replacing that system altogether? If so, do you know of our have any ideas on what system might work well for the world?

No, I wouldn't go so far as to propose abolishing fractional reserve. The entire world wide system is built on that concept. I think I'll pass on that and wait for the world's magnetic polarity to do it's periodic shift north pole to south pole as it has in the past. At that time bankers might be ready to abandon fractional reserve. Say. . another fifteen thousand years?

My specific intent (which would have been addressed more succinctly in the upcoming consideration of accounting) is in new regulations and modified accounting procedures, which as you intimated elsewhere would move any new derivatives from the memoranda directly to the balance sheet. That would also provide the transparency and force banks to exercise care in floating unsupported instruments or indiscriminate fiduciary media. Events like the current situation would stand out like a beacon before the situation became toxic. If a bank knew they'd show a sudden, tremendous negative balance sheet. It would force them to be a great deal more careful and prudent in the use of derivatives.

Every contract I held which had value was an asset. If it did not, it was a liability and effected my net worth. Why should banks be entitled to the privilege of reporting trash in the memoranda? The old derivatives would simply be retired and that entry would die a slow death. That's the long-term integrity I referred to.
I’m not sure the tax payers really want all that toxic debt on their books.

Nor would I like to see it on the Fed's books. My proposal would be to have the people who foisted this scam on the world and pocketed those fees for doing so, be forced to negotiate to retire the contracts at their expense. I don't really care if it causes personal debt on their part to do so. That's their minimum sentence.

I do care if they try to pass the expense on to the depositors or taxpayers by burying it in the books under an exotic name or try passing it on to the Fed, causing the Fed to deduct the obligation from the balance which would ordinarily pass on to the Treasury's account at year's end. Failure to pass that money on to the Treasury, BTW, would reduce the revenue for the general fund and create greater expense to the taxpayer and the nation. We're already losing enough by way of the Fed's peccadilloes and mismanagement at this point.



I agree that the Fed has backed itself into a corner. It may be bruised but I think with some heads up management, it can save itself. Although it may need more management skill than a university professor can provide.

[comokate]

Post 31)
Are you talking about modifying the fractional reserve system or more radically, replacing that system altogether? If so, do you know of our have any ideas on what system might work well for the world?

No, I wouldn't go so far as to propose abolishing fractional reserve. The entire world wide system is built on that concept. I think I'll pass on that and wait for the world's magnetic polarity to do it's periodic shift north pole to south pole as it has in the past. At that time bankers might be ready to abandon fractional reserve. Say. . another fifteen thousand years?

My specific intent (which would have been addressed more succinctly in the upcoming consideration of accounting) is in new regulations and modified accounting procedures, which as you intimated elsewhere would move any new derivatives from the memoranda directly to the balance sheet. That would also provide the transparency and force banks to exercise care in floating unsupported instruments or indiscriminate fiduciary media. Events like the current situation would stand out like a beacon before the situation became toxic. If a bank knew they'd show a sudden, tremendous negative balance sheet. It would force them to be a great deal more careful and prudent in the use of derivatives.

Every contract I held which had value was an asset. If it did not, it was a liability and effected my net worth. Why should banks be entitled to the privilege of reporting trash in the memoranda? The old derivatives would simply be retired and that entry would die a slow death. That's the long-term integrity I referred to.
I’m not sure the tax payers really want all that toxic debt on their books.

Nor would I like to see it on the Fed's books. My proposal would be to have the people who foisted this scam on the world and pocketed those fees for doing so, be forced to negotiate to retire the contracts at their expense. I don't really care if it causes personal debt on their part to do so. That's their minimum sentence.

I do care if they try to pass the expense on to the depositors or taxpayers by burying it in the books under an exotic name or try passing it on to the Fed, causing the Fed to deduct the obligation from the balance which would ordinarily pass on to the Treasury's account at year's end. Failure to pass that money on to the Treasury, BTW, would reduce the revenue for the general fund and create greater expense to the taxpayer and the nation. We're already losing enough by way of the Fed's peccadilloes and mismanagement at this point.



I agree that the Fed has backed itself into a corner. It may be bruised but I think with some heads up management, it can save itself. Although it may need more management skill than a university professor can provide.

[comokate]

Post 32)
No more knee jerk response. Suspend all but the absolutely necessary movement of money or purchase orders. And that will be cleared through this office. From this moment on we're going to do it the right way. The way that strengthens our position and assures us of a future, that we can open the doors tomorrow morning and have a place to work! In the meantime, we'll all go to work, every one of us, on straightening this mess out."

You'd be surprised how the head honcho leans back and breathes a sigh of relief. It's as though he wanted that done all along, but didn't have the courage or know how to do it himself.
Post 33)
What Bernanke should be doing right now is pouring over the books or standing over the heads of people who were doing it. Geithner should be preparing himself the same way. Everybody in a position of authority should have something in their hands, on their desk, in their minds, and there should be no upper echelon meetings whose only purpose is to avoid facing up to the burning issues of the moment, with a bunch of inept executives wringing their hands and wondering what we should be doing next. They should be asking, WHAT AM I DOING NOW? WHAT COULD I BE DOING NOW? We need SPECIFIC answers to DIRECT questions. WHAT IS THE PROBLEM? WHERE ARE WE NOW? HOW BAD IS IT? HOW MUCH DO WE NEED? WHAT CAUSED IT? We all know, of course, we're doing none of that. Records exist that detail all the skullduggery which caused the crisis. GET THOSE RECORDS ON MY DESK BEFORE YOU GO HOME TONIGHT OR DON'T GO HOME!! THE WORLD'S WAITING FOR OUR ANSWERS! I'm sorry, but I don't see the results that indicate that those in power are taking this matter seriously. The politicians may still be gloating over the marvelous win they had in the last election, the appointees reveling in the glory of their new offices. That election was 3 months ago and the euphoria should have subsided by now. The gravity of the situation should be in their face night and day.
This may very have been the situation FDR faced when he took office and declared a bank holiday. If we can't handle the gathering of data, perhaps we should declare another holiday until we get a grasp on the truth of the situation.

I followed your link and it stirred a memory. Huerta de Soto's book is about 900 pages long! I picked it up , thumbed through it and stopped at a page from which I took this quote
The above sheds light on monetarists’ lack of a satisfactory theory of economic cycles and on their belief that crises and depressions are caused merely by a “monetary contraction.” This is a naive and superficial diagnosis which confuses the cause with the effect. As we know, economic crises arise because credit expansion and inflation first distort the productive structure through a complex process which later manifests itself in a crisis, monetary squeeze, and recession. Attributing crises to a monetary contraction is like attributing measles to the fever and rash which accompany it. This explanation of cycles can only be upheld by the scientistic, ultraempirical methodology of monetarist macroeconomics, an approach which lacks a temporal theory of capital.
I supplied the bold letters for emphasis. Isn't that exactly what we're experiencing

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Post 34)
As observers, we should recognize two obstacles in the way of viable solution:
1. Bernanke is not working for the US citizens, the nation's economies or even businesses. His interest begins and ends with the banks. In this role, his choices, plans, etc. are tainted and his policies, programs, etc, are less than effective for the benefit of the wider base which is our concern. He's not likely to come out and reveal truths destructive to banks' images. Banks need to be corralled and tamed to serve their basic function and abandon investment market activities.That task is considerably smaller than revamping our economic or financial system and only as difficult as penetrating that obstinacy which claims the public has no right to interfere with banks' operations. But, if banks' business is the business of the US, it IS our business how they corrupt the monetary system and despoil our economy!
2. Geithner is another career politician/banker. Whether the fact that he has more Washington experience than Paulson is an asset for the nation as a whole or not remains to be proven. A resume is impressive, but it doesn't do the work.The person does that. We have yet to determine his character. Once thrown into the Washington basket and mixed with the other personalities, personal attributes may be overwhelmed and no longer discernible.It may be impossible to find someone with the training, experience and intelligence capable of approaching the problem without prejudice and with an open mind. If there is such a person available, the politicians in charge may be suspicious or distrustful of him/her, or bear down so hard to advance their agenda, he/she would have no room to work. Just bear in mind what happened to Brooksley Born for calling a spade a spade, and, more recently, that Geithner wanted to roust Sheila Bair from her post for little other discernible reason than she was a shining star and might detract from his spotlight.
Post 35)
When any administration encounters someone who goes around shaking trees and bushes to see what flies out, they are uncomfortable. Invariably this means that the flaws are being exposed and something different needs to be done to the system. Confrontations, wrangling, and fire and brimstone threats follow. All factions are searching for the quietude that ensues when everybody does thing "my way". Currently, there must be about a thousand "my ways" extant, each one anxious to dominate and prepared to fight off dissenters.

The diplomats might be looking for the middle road. But, the middle road is not going to get us to safe ground. It's flooded with corruption there, too.

Post 36)
For the sake of those not thoroughly versed in the the purpose and procedure of accounting, its intent is to present an accurate picture of the financial condition of an enterprise at various times. The two most important questions to be answered are (1) what is an enterprise's present condition, how has it fared over a longer period?
Two sides of the ledger are used and those items which are helpful, meaning adding value to the enterprise, are entered on one side and those which are hindering operations, or detracting from value are entered on the other. Simple process. You owe me or I owe you; it has value, or it's costing me to carry it. The two columns are summarized, balanced off and the managers of the enterprise know whether they are rolling in gold dust or bankrupt.
Each item is assigned a value in dollars and cents. In normal circumstances, evaluation causes no problems. We made this item and you agreed to buy for so much. Value is determined for contracts. We spend so much for goods, so much for labor, add in provisions for taxes, fees, expenses and a little profit and that's the cost, or price. Entries are made on a daily basis, and at the end of the month, the columns are tallied and the owner knows how he's fared for the month. Year's end, all is tallied again and he/she has a good picture of how the business has fared over the longer term.
More than expectation, there's a demand that entries will be kept up to date. The more complex the enterprise, the more demanding the bookkeeping activity. There is absolutely no excuse for bookkeeping to fall behind activity besides management's desire not to know or not to allow anyone else know their financial condition. Truth is, a practiced eye can walk through an enterprise, assess it's scale of business, look at work in progress and a few other odds an ends and conclude whether or not a business is operating on sound principles and is solvent. Several times, during the preliminary interview and survey, by the time fee negotiations were entered into, schedules were arranged around an insistent demand for pre-payment. Accounting and ledgers tell a story, but so does experience.
My experience tells me and a lot of the folks reading or posting here, that they are as convinced as I am that Banks have a problem. If an industry is shrouded in secrecy to the extent that the banking industry now is, the lack of news is not good. Mr. Kanjorski (spelling?), Congressman from Pennsylvania, revealed recently that the hedge funds had a run on Sept 15th which drained $500+ billion in about a half hour. Had there not been a stop arranged, the estimate was that about $3.5 billion would have been drained from the hedge funds in the next 2 hours! My professional intuition tells me, as far as solidity or stability is concerned, what is true of the investment industry is true of the banking industry.
It's impossible to imagine that the banking or brokering industries do not have accountants hard at work tallying assets and liabilities on better than an daily basis, probably more than twice a day. They know what their condition is.

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Post 37)
If the Fed were to ask for that information, it would be provided. I'm sure if Congressional committees asked for such information and it was not forthcoming, there would be coverage in the news media detailing the non-compliance.So, what possibly could be the problem? Is the situation so severe that no one dares release such information to the public for fear of a run? Is a collapse imminent? Considering all the emphasis on "sunshine" government, do the authorities have the right to keep such information from us? Is there really such a possibility that the market does not exist which can assign value to the toxic paper? If no market will assign value, then value is ZERO! Now, close the books using that value and release the information to the public!
Post 38)
If the banks and brokers consider this not a "fair value" accounting, I'd instruct them to provide their own assessment using realistic guidelines, Marked to market, or reversion to "lesser than" treatments, taking into account the stressed markets. If the vehicles are illiquid, own up to it.The embarrassment to the bankers is that they have not tended to banking business, Previously I mentioned that there are only two legitimate banking activities in which banks engage, loans based on money and credit generation based on fiduciary media. If you followed traelin's message # 69, and read the blog attributed to Jesus Huerta de Soto, you realize that one of his points is the inadequacy of reserves. If loss reserves are inadequate, the credit cycle is interrupted and businesses dependent on "revolving credit" suffer severely even if not to the extent of being forced to close their doors.Since one half of the principle area of banking business proper is extending loans based on depositors funds, depositors interests should be foremost in the minds of bankers. Depositors have a right to know if their money is safe. Most people deposit in banks because they do not trust alternatives for the amounts involved, or there are no alternatives. That doesn't give banks the right to treat depositors funds with impunity.There must be, there should be open reporting and accounting on reserves and any expectations of losses due to careless investing on the part of bankers. Depositors should know what has been invested, where, how much, what is the current valuation and how has the price been verified.

Once this has been opened to the public, we'll know where the banks stand and how solidly they are set up.

Until that is complied with, I will continue to suspect banks are engaged in business not generally considered properly a banks' activity.

[comokate]

Post 39)
"good faith" and "uniform standards" by all means! But, bear in mind that uniform standards must be flexible enough to extend beyond US borders.

This aspect will be dealt with a little further along. A reference is made to it below in the reaction to your Citi observation.

Among the problems which should be discussed are the international markets, communication between domestic and foreign banks and markets, etc. The electronic aspect of money and banking has already been introduced, with some reference to a limitless, unregulated and strangulating threat should it be left unattended.

Whatever is done to correct and/or regulate the stressed markets situation, even if it doesn't approach what you or I would prefer and ends up being little more than "alleviating tension" will have ramifications which must acknowledge foreign markets and banking systems. We're too intertwined and interrelated, too easily in communication to do otherwise.



A committee "independent" and "insulated" from politicians, a given! However, caution might be in order as to how large the group is, though it should not limit itself as far as who should be consulted. You're right in mentioning all those effected disciplines. They definitely should have input to inform those who'd eventually formulate the conditions for the revised or corrected system. Perhaps, this might be done on a contributing or consulting basis.

Too large a group here might not be a good idea. Eventually they might become the equivalent of muscle bound, unable to enact a thing not only because of the unmanageable mass of diversified ideas, but the customs and different approaches to conducting business. Keep in mind what happens in Congress. . . there's a large group with diversified opinions. You need a total catastrophe to get them to agree to anything. . and when they do agree to a solution, it's usually in a form or to a degree that everyone regrets.

As for models, it's not advisable to stray from the idea of the practical concepts on which most of the markets world wide are modeled. They use electronics to report results, but pricing is a matter of, "You offer for sale and I'll tell you what I'll pay!" And, then they wait to see if there are other bidders. Presenting a developed price and in most world-wide locations, is an invitation to disaster.

Still, I believe you may be acknowledging this when you say "truly standardized fair market evaluation" with which I am in complete agreement as long as the international flavor is respected.
Post 40)
In the end the international markets will have to participate for several reasons among which are their complicity and the need for the largest possible market to dispose of or resolve the issues of these questionable instruments. Final comment on your post #78: Banks like Citi - large, extensive world wide branches. . in excess of 150! - complex constructs, multi-departmentalized, with diverse activities - such banks are in need of more attention than are the more restricted entities. It may be advisable to subject them to more control, regulation and supervision then smaller entities. The slightest accidental hiccup by banks of that size cause more problems than intentional destructive actions by smaller banks.

No question that such banks need special treatment not only for control, but in the event they create a situation which they are incapable of resolving. Citi's size in the US is still a fraction of the GDP or creditworthiness of the US govt. The Federal Reserve Banks would be able to handle them should they go astray. But what of the smaller countries and some of their larger banks which dwarf the GDP or the resources of the entire country? If the Cayman Islands' Banks or the banks of Lichtenstein or Luxemberg, with all their massive foreign deposits would ever run aground, those countries would not be able to deal with it. Someone will have to be prepared to step in and handle their problems. . . That's another of the international consequences of any new proposals in need of consideration.

Allowing a weak link in the international system to survive, means the "players" will take advantage of it and the next assault may very well originate from some far-off minimal outpost ban.

[comokate]

Post 41)
Nouriel Roubini is being conservative deliberately. The true price is out of reach. That's why using some banking slight of hand to squelch these derivatives and other toxic instruments we've distributed world wide is advisable. The technique is simple enough if the group who holds the contracts gets together with, first, the realization that nobody is going to pay these things off or collect on them; and, secondly, it's to their own best interest to get them off the books and free up the banking system preparing for more fun and games down the line.
The interested parties have to sit down, see who owns the other end of the contracts they hold, be they guarantor or beneficiary, contact them and make the exchanges that are necessary to balance out the two accounts. Cancel the matches and hold the unmatched. They'll come into play in the next go around. Player by player, they continue to do the same thing, cancelling what matches so that it's a wash and putting aside the unmatched until later. (It may sound complicated but with today's computers, the matches can be found with relative ease.) The principle behind this is that the claim and counterclaim end up with the same party and there is no contract. If you are both guarantor and beneficiary, it cancels out. You can't have a contract with yourself. They'll carry this on until they end up with contracts that have no counterparty. Believe it or not, such contracts are out there! People bought things on which no one is going to pay hoping they could sell it and collect a commission. They bought contracts on contracts until there was no where else to go.
They'll resist because someone has to put money back in the till to replace the contract fee that was deducted as a commission!
But, that's the most convenient way of disposing of these things. Simple cancellation. Its a technique that's used daily in clearing houses throughout the world.
Even if the commissions are not restored to the cycle, the claims on the contracts would be reduced to near inconsequential denominations. . . to the level which can be handled.
From the latest published FDIC balance sheets, from June 30, 2008 to Sept 30, 2008 there was a reported contraction from $183 trillion to $177 trillion in total derivatives (fewer banks reporting)! Where did that evaporating "notional value" go (if it did)? I believe they are at work with this scheme or something similar already, hoping against hope that they can work something out before they're required to open the books for the new supervisors coming down the pike. It could end up costing them more in fees, fines and loss of licenses and they are scared ########!
I anticipate that the totals will be less as of December 31, 2008 and each three month reporting period following. Unfortunately, the world economies cannot wait for this low rate of retraction. $6 trillion in 3 months is not nearly fast enough to dispose of the flaky junk out there. Probably of the entire mess, somewhere in the neighborhood of $3 to $7 trillion are legitimate derivatives. At the rate of $6 trillion per quarter that's about 30 quarters or seven years+ to dispose of the junk. It's got to speed up. We can't put the banking system on hold for seven years.

[comokate]

Post 42)
What they Don't want, is to be forced to put their couple of million back in the pot.
To unravel this formula, they = each and every one of handlers who took a cut of the commissions involved, and the couple of million I refer to are their fees for duping the financial world and the regulators.
Derivatives worked in such a way:
At the outset, there were legitimate actuarial calculations as to the cost of insuring whatever they selected. For a laughable example, Enron wanted to insure against weather interfering with their distribution of power to California from various locations and sought to establish a market for "Weather derivatives". (That failed to initiate. Why? It's anyone's guess.) But to follow the intent: let's say that weather does go against Enron's interest. In that event they collect. To extend this concept, any kind of adverse situation which induces a loss is eligible to have derivative contracts written against loss. There are interest rate contracts, Foreign exchange rate contracts, Contracts on commodities and all manner of equities, etc. The contracting bank might retain some of the more reasonable contracts for their own benefit. Some of these have the bank listed as Beneficiary, to collect in case of failure, or, as Guarantor, to pay in the event of failure.
There was bidding on an open market to buy these derivatives. Various potential buyers would try to calculate the likelihood of failure and the obligation to payoff. They might believe the likelihood was 3% or 5%. Prudent insurance rules dictate that you should add to the most likely failure figure to determine the premium. These were not insurance people. They considered derivatives to be a sure thing, since what they intended to do was issue the derivative contract at some bargain basement price, then pass it on to someone else to sustain the loss in event of failure. So, if they thought 5% was a fair premium, they were willing to bid 4.5% or 4%, since dumping them on a third party would cost them nothing, and they even probably tack a fee on for doing that. They'd take the fee and move on to the next promising proposition.Since other players entered the market to compete for this marvelous opportunity for making money from nothing, taking a simple quarter of a percent off the most likely percentage for failure no longer secured the sale. Someone else underbid you by a quarter or half a percent. So, in order not to lose out on this easy money, the boss instructs, from now on figure the failure rate and bid three quarters under that. And the bidding continued. It made no difference, nobody was holding onto the contracts. Even the second and third tier buyers were dumping them as soon as they could.

When they ran out of issues on which they could base the derivatives, they insured the derivatives! They were issuing derivatives on absolutely nothing.

In 1992 total derivatives in the US was in the order of $8.7 trillion; 6/30/2008, total derivatives stood at $183 trillion!

[comokate]

Post 43)
Total bank assets of all institutions reporting in 1992 stood at $4.5 trillion; 6/30/2008, total assets stood at $13.3 trillion. The ratio jumped from 1.93 to 13.76!
Now, there's an exponential growth for you!
Where I might differ from your assumption that it would work out for banks, it doesn't. There is not that much GDP nor that that many assets distributed through the US to justify $183 trillion of derivatives, nor in the rest of the world to justify what has been estimated at $317 trillion, for that matter. So, since they aren't insuring anything, the banks all woke up one morning and said, No way, Jose! If It fails, I don't pay! So this totally useless monster pile of contracts are setting out there and no Beneficiary will collect and no Guarantor will pay. Yet, the banks are on the hook not only for the contracts they hold, but, more importantly, for the very real cash that was withdrawn from bank reserves and depositors accounts to pay the fees to the handlers of the derivatives.

Post 44)

Our current crisis defies categorization as either 100% inflation or deflation. I knew a German woman who responded to my attempt to classify her by saying, "Nothing and nobody is 100% anything!" There was a conviction behind the statement that rendered it unforgettable.Our situation is not 100% anything! It's partially deflationary, but leaning more toward inflationary. If the deflating housing issue and the lock up of the credit market are ignored, neither of which are pricing issues, inflation is pretty much in evidence.Yet, Bernanke is (and has been) fighting deflation! Why? You'd have to ask him. A guess might assign impure motives to the man (which I've done!), but that notwithstanding, I do question his impartiality, bearing in mind his role as a banker's steward.What's missing from the box of evidence collected at the scene of the crime are the balance sheets and the cash flow summaries which would help us trace the origin, distribution and magnitude of the scandal as well as point fingers conclusively in the direction of those responsible for our problem. To claim that the bankers at the helm, the FDIC, and the Fed do not have access to such conclusive evidence is a tubful of the well know swill. Incriminating records such as these are usually found months later in an abandoned warehouse, under a ton of tarps. They exist as sure as shootin'. And they are as incriminating as the bloody knife and the footprints at the scene.

If Jeremy Grantham knows for a fact that we're lacking $10 or $15 trillion dollars to clean up the debt, he has access to the papers the bankers do not want us to see. Whatever the debt is, I believe the situation can be cleared up with a great deal less than that. If he insists that we need that much, he's only shilling for the banks who are still holding out the tin cups and poor mouthing the taxpayers. There's a concealed leveraging factor which may be 2X and it may be 20X, but which can only be determined by a forensic search through the balance sheets and by retracing the cash flow path back to the crime. This, we are not likely to see. Those sheets are in a dusty box in an abandoned warehouse under tons of tarps beside the buckets of swill, out of harm's way, safe from any possible discovery until we're all dead and the crisis is no longer a memory.

Neither Grantham, nor Das, nor Bernanke are saying anything pertaining directly to our situation, nor are the bankers, nor are the posturing Congress people wailing away at the conspiracy, some of them earnestly frustrated and some of them in the know but acting their hearts out trying to convince constituents they are concerned for the voters' sake.

Given the bi-directional trend of our double-headed economic monster, picking a single strategy and following that note for note as the score was written 6 years ago, does not and will never suit the situation or lead us to a resolution. I suggested consulting that speech to point out that six years ago Bernanke developed a program to fight something and today he's using for a totally different scenario.