So either we are going to ignore the rules or get rid of them. This undoubtedly will allow banks to show better earnings over the next few quarters (thus the rally in stocks) just because they don’t have to write down values, even though it changes nothing.

Eventually enough of the debt will either default or be forced to be restructured; then banks will be forced to take even bigger write-offs. Either that or the government will print massive amounts of dollars to buy it up, which will have the same effect on the economy: for then the Chinese will balk and hyper-inflation will ensue like an infection.

But as our government continues down this path of destruction let’s at least learn a few lessons. As this debt was created, mark-to-market rules were not employed properly.

Let’s say instead of too much debt we created too many cars. As the car company was building too many of them, at some point inventories of cars would begin to rise. The car company then has a choice. It can either ignore reality, value the inventory at the last price at which a car was sold, keep building cars, and keep building inventory; or it can realize that it built too many cars, stop building them, lower the price of cars, and reduce the inventory.

Which do you think is logical? If they kept building the cars, kept showing profits by assuming they were going to sell the cars at the last price of cars, what would you expect the results to eventually be? Hopefully you would conclude that prices will go down dramatically once the car company began to try to reduce its vast inventory. Price goes down when supply goes up! I guess it’s too much to expect Congress to understand this simple and long tested economic axiom.

The problem with bank debt is that the regulators along with the banks never properly applied the fact that the more debt you create, the harder it would be to support that debt and collect on that debt. Now there is so much debt the amount of private capital to buy that debt is insufficient, at least at the price the banks want to sell it at.

It is a flawed argument that the debt is worth more than the market wants to pay for it. How much the debt is eventually worth is a function of default rates, the level of income being produced by the economy, and the value of the dollar. From what we see now of the economy, default rates will get worse not better; but perhaps it is because there is so much debt that the economy is getting worse. There is simply not enough real income being generated by the economy to support the debt or to support wishful default rates.

That is all incorporated in the current price it would take to sell the debt today, which is much lower than where banks have it valued and where the government wants us to believe that it can be sold. Once again they will cajole taxpayers into believing this is a good deal to buy it at higher prices, but it will result in a much lower value of the dollar or worse for our children.
Citibank (C) and JPMorgan (JPM) leaked that they are going to make money this quarter. They are going to show profits by 1. not having to write-down assets further due to looser mark to market application and 2. they're being handed money by the government by being allowed to short the 2-year Treasury bond at a low interest rate and take the cash and buy government-guaranteed Fannie Mae (FNM) paper at a higher interest rate. This “carry” trade is being subsidized by the US taxpayer and is costing us “money” every day.

It’s going to happen and is happening, their shenanigans on accounting. But the downside is transparency, or lack thereof. The market will see through the problem, realize that the earnings banks report are highly suspect or false, and eventually not provide needed capital.

But remember this. We have tried to arm you with information to battle this deflation (destruction of debt). Let’s summarize. For the last 30 years economies, mainly through central bank fiat currency regimes, have been levering. Companies used to depreciate assets like real estate to zero and hold them there so as to avoid taxes: this was so because most of the companies’ stock was held by insiders. As owners sold shares to the public they monetized the value of those assets.

Central banks gave the public leverage to pay for it. The next step was for the public to lever their own assets. Developed economies now have so much debt it is unsupportable by real wealth. We are in the deflation of all deflations. When you create debt (inflation) you increase artificial liquidity; thus, when you destroy debt you reduce liquidity. Lower liquidity, lower prices.

Only lower prices -- much lower prices -- will bring back liquidity.

Risk is high