OK, we have too much debt.

Can't the debt be paid back without a massive deflation through growth in the economy?

How about looking at it this way. A homebuyer who earns $30,000 a year buys a $180,000 home with nothing down and a 5% mortgage rate. That's a $11,592 in yearly payments. Isn't that manageable?

Yikes, I keep commenting on Mr. P's posts. I gotta get a life.

Thanks for the great synopsis about Bear, debt, etc.

"When the government does announce a $1 trillion trust to buy mortgages it will be with our kids' standard of living."

Are you saying that normal people who buy with 80% debt are properly enjoined to pay significantly for the, let us say, excesses, of the !#$#@%'s who created the CDS mountain? I don't agree. (Well, ya, CDS's helped securitize the debt...).

Systematically deconstruct the CDS mountain by "helping" all the investment banks into bankruptcy. Whatever.

Also, if the govt. does buy <mortgages> (v. derivatives), most of them will probably be good investments, no?

Bill

Bill the first
The issue is not mortgages. Everyone seems to be confused about this. In the article MP says that the issue is the derivatives (CDS's mainly). (Well, you can't have derivatives without a thing from which to derive a derivative I guess). Thanks
Bill the second

Mr. P,

Great posts - always. I believe you are right, as usual.

The Great American Debt Experiment is over. They can't give loans away. The last vast target group for debt was the subprime markets. If the banks had real capital AND they wanted to loan it out - there is not another "next" huge market for loans!

A man once said: "Things could always be worse". I guess in this case he meant: the profiteers could have mortgaged the super-subprime market, too. So, we have that going for us, eh?

Sadly, I concur with your last sentence as a strong probability - versus a remote possibility. It is the road our beloved FED is steering us towards.

Cheers and fears. God help us all, but mostly our children and their children.

The fundamentals of what makes a country, a society, an economy, and why we have financial systems need to be reviewed again and again. An economy is built on real goods meeting real needs. Value is a Net Creative Future Usefulness Potential. In other words, can you birth, grow, build, or save something with it? Then it has value.
These 'derivatives' are simply a tool to disconnect money from the things that create real value, and fool people into thinking they get to ride along on 'free' money, which is not Value. In historical terms, this is called "usury", because it disconnects the feedback of the value of a person's labors from the price one pays for those labors. It makes the exchange of business into an unfair exchange, applying pseudovalue to the money itself, and this action is one of Blind Faith in Systems. Any action taken based upon Blind Faith is Evil. Evil acts inevitably lead to some kind of disaster or failure.
There is no 'cure' at this point, since the real value of real people has been leveraged exponentially, and there isn't an exponentially available number of planets or petroleum to build a real economy large enough to pay for the promises (lies) which the government and the financial industries have put to paper.
The game is over, but everyone is too drunk to drive home yet. When they do, they will find there is no more cow to milk, no magic beans to climb to free gold, and no witch that's going to turn over a new leaf and grant us all happiness.
It's time to roll up the sleeves, tear down the facades, and start building real houses, real communities, and real networks of real value with the one resource we can't seem to apply: ourselves.
Anyone who tells you different is selling something.
Eat the salesmen and the missionaries who bring them.

i don't have any children. there are plenty of needy people out there whom i can give to, i have never felt the desire to bring more need into the system

i first realized the perverseness of the system on opening day at kansas state university. when i went to buy books, i was flabberghasted at the prices. i said to myself. "this is highway robbery!" i could have afforded new books easily, just based on finances, but my gut feeling told me i needed to buy used ones (and overlook the marks previous students had put in them)

ever since that day, my opinion of society and government has been pretty much in the toilet (i will say however that most of my professors were top notch, and that the dept. of geology was well respected in the industry)

Dan I agree completely, but the question is whether our natural resources (especially energy) will be there to do this. It's the same answer to Bill the 1st. Sure we could pay off that debt, but we need to be able to produce enough to continue living and have extra to pay it down. Considering how much debt is required just to maintain our living this is nearly impossible.

We really need a series of technological breakthroughs/societal changes that completely revolutionize how we create and consume.

Any way to see a graph with this "other" debt included.

I've read in a few places now, that the CDS debt isn't really "completely" debt because - well, you know - this CDS owes that guy, but THAT is covered by this one, so THAT doesn't really own THIS the total amount; and in a real pinch, the total REAL CDS debt would be, oh, pretty well manageable and nothing to really worry about, kinda like the Alt-A problem.

Anybody know "the truth"?

Bill. with more and more American jobs on the chopping block, where do you see this money comong from?

To maintain a strong economy a country is supposed to export goods not jobs.

I can't believe that people have been so blinded by business and political rhetoric that our current dilemma comes as any great surprise. We as a nation have begun to believe our own cold war era hype. The leaders of industry saw themselves as invincable and slowly we have lost the cutting edge.

Is there no-one in America who can build the best car with American labor? Or a T.V. or radio .I think we as a people need to reevaluate our sence of entitlement. Lose the insurance industry from the medical profession. How much money could that save? We need to be willing to work for our money instead of relying on the promise of 401K.

The banking industry had to know that the bottom would fall out of housing. Someone had to be aware of the ever growing trend of outsourcing American jobs and that people were buying into something that was destined to be unsustainable.

If a company goes belly up, so be it. Are the powers that be going to be so forgiving of a private person? I think not. The leadership of this country be it in industry or the political arena need to learn to stop buying if you can't afford it.

Let the entire thing bottom out . let the chips fall where they may. Maybe then a little humility might creep in and make us all better people.

Ancient Greece fell. Ancient Rome fell. WE can too.

FakeBen thinks the Fed will lower reserve ratios for banks and set up a trust fund to buy mortgage debt. FakeBen.com

How much of the activity is necessary in the first place? What are people for if not to do things manually? Most of the economic activity is simply sucking resources out of the ground and then dumping them in landfills or into the air. We would be better off to pay people to stay home and grow gardens than to 'create financial and economic instruments' or whatever bulls...t they call it these days when what they are really doing is stealing from the future to maintain the unmaintainable 'now'. It's over, we just have to figure out where to pull the plug and go home.
Last one out of New York, please close the gate.

I find your thoughts insightful and valuable in thinking about the direction of the economy, but I think you went a little too far in this one.

I'll accept that the derivative debt is some large multiple of GDP. For the worst case, see Nouriel Roubini. But I don't accept that:

--one failure in the "string" means they will all fail. We've already had institutional failures (BSC), massive writedowns if not writeoffs on RMBSs and the like, and yet we're still chugging along albeit not strongly.

--all that debt is in the US. Indeed, the globalization of the debt means that many of those leveraged derivatives are owned somewhere besides the US. That's the good news. The bad news is that their unwinding would have global, not just national, effects.

--the "crazy things" bureaucrats are doing ARE working, at least to some extent, in slowing the unwinding of bad mortgages and their related derivatives. The Fed deserves kudos, not disrespect, for what it has done, even if it was intially slow to respond. It would appear that it has caught up with the market now. I give less credit to the Administration and Congress.

So it's not like a plunge in the global economy is inevitable in the face of greatly overextended debt. We just need to be diligent in controlling the unwind so that critical institutions and proceses are not overwhelmed in the course of events.

I think this idea of "critical institutions" is bull-crap invented by Wall Street to scare regular American tax payers into footing the bill everytime they screw us. Was Enron a critical institution since it was trading something like half the energy in the U.S. NO - it failed - it went away - the more honest players picked up the shattered remains at fire sale prices, making their businesses and balance sheets stronger. For every Bear Stearns that is allowed to collapse there will always be a Leucadia National Corporation or a Berkshire Hathaway waiting with cash in hand to scoop up the pieces, send the overpaid CEOs packing, and get on with the business of running a real company, with a real balance sheet. By preserving so called critical institutions the government merely prevents the market from correctly pricing risk and assets until we end up with the kind of sham financial economy that we have unwinding today. By interfering with the market the government prevents the patient conservative investors who quietly bide their time and avoid getting caught up in the greed fest from reaping the rewards of the harvest. But we reap what we sow, and now the fed is reaping all that debt off the balance sheets of the "critical" - albeit worthless -"institutions", and, unfortunately, in America, where we have government of the people, for the people, by the people - all that debt will become the people's debt and be split up and paid off by us and our children. The "venerable", "critical institutions" should be allowed to fail. All that happens is the company begins operating in bankruptcy. If the company has a sound business plan and a future as a going concern, then the courts will work out a plan and find a buyer. If Citigroup, Bank of America, Merrill Lynch, Goldman Sachs, Country-wide, UBS, Morgan Stanley, Bear Stearns, Lehman Brothers, etc. were to go bankrupt, the effect on the average American is basically zero. They keep going to the bank and withdrawing their savings to send to their grandchildren on their birthdays. The courts work out the destruction of debt as necessary. The sophisticated investors get burned - as it should be. The bumbling "swimming naked" CEOs get tossed with no golden parachute by the bankruptcy judge - as it should be. The lawyers file suit on behalf of their clients - as it will be. It all gets worked out. Some true investor puts up the cash and an operating plan to shephard the company out of bankruptcy. As far as I am concerned, the more destruction of debt and the greater the pain, the better it is for the health of the economy in the long run. Remember the pain of the great depression - of course not - you weren't even alive, which is exactly why we are in this mess!

I would consider the Fed, the Treasury, and their foreign counterparts, and a few multilateral organizations (BIS for example) "critical institutions." I certainly don't consider the commercial thieves of Wall Street critical. I'd like to see some of them go down big.

I agree - there are some critical governmental institutions. I do believe in regulating the greed driven financial markets. I think it is usually a mistake to rescue a private company from its own folly. Looking at an example of a successful rescue, one that even paid back the rescue to the government - Chrysler. In the end what do we get? Chrysler is an unmitigated disaster - wholly out of touch with reality - putting out products that are ghastly in appearance and out of synch with economic realities. It should have been allowed to fail back in the days of Lee Iacoca and the auto market as a whole in the U.S. would be healthier and more in touch with the need to make products that will have a consistent demand curve instead of catering to every little trend or short term market dynamics like cheap oil. The financials, if allowed to fail, will reform themselves in ways to insure such folly never happens again. It is only 20 years since the last big government bailout of the financials in a credit crunch due to unrestrained lending - the S & L meltdown. Fractional lending should be phased out. I used to knock myself out trying to figure out how house prices, medical prices, and education prices all go up 7% a year and the government tells us inflation is only 2-3%. Housing and medical alone are more than half the U.S. economy. Obviously they are cooking the books on inflation for political purposes. The fed and government caused this problem by allowing fractional lending by banks on money they gave the banks essentially for free. The greed driven banks and brokerages, levered up an insane 30-1, with no hope of solvency in the presence of even the smallest market disruption, forgot everything they ever learned in economics about supply and demand, business cycles, opportunity cost, debt/income ratios, the invisible hand (that slaps and spanks anyone who is an idiot). The Fed is not a critical institution as they currently operate. They are a big part of the problem. Listening to Paulsen's proposed reforms made me ill - the Fed as stabilizer of the markets!?? The Fed's main job is interest rate policy and they have screwed that up sooooo bad. The Fed's idea of stabilizing the market is preventing the repricing of assets to rational levels! The Fed is the problem. They interpret market stabilization as maintenance of the status quo and insuring rich people don't lose out on their speculative investments. The Fed created the atmosphere for the irrational overpricing of housing over a long period of time and now they are trying preserve the value of the securities backed by the overpriced housing stock by taking them off the market and on their balance sheets. It won't work though. The invisible hand of Adam Smith says that when you have an asset like housing - that represents something like half the nation's economy - you simply can't finance its price escalation at a rate any higher than income inflation or eventually the two diverging curves will be forced to converge causing major upheaval. Housing has 25% left to correct before it realligns with historic income growth. An asset that big simply can't outpace income growth in the economy. The same goes for medical and education expenses. Education and public service - the last sectors of the economy that still maintain generous defined benefit pension plans must be reformed inline with private sector benefits. Teachers who complain about how poorly they are paid - don't listen to them. I'm a financial advisor and they are one of the few groups of people I meet with who, as a whole, are sitting pretty for retirement. The medical industry - like housing - can't forever accelerate their cost to the economy at double and triple the rate of income growth. It is unsustainable - like the penny that doubles everyday until a month later you are a multi-millionaire. The Fed is very oriented toward promoting and encouraging the leverage and lending that allows all these things to happen. The Fed exists to service and facilitate leverage and lending and rescue large banks and Wall Street firms from collapse when these institutions forget the most basic concept of banking - never borrow short and lend long. Forgetting this concept is ALWAYS the reason for disruption in the credit markets. The ONLY thing the Fed needs to do to insure this never happens again is to have a mechanism in place to regulate what capital is backing what lending and match durations. It also makes sense to phase in a dramatic curtailing of fractional lending which multiplies risk on a fixed amount of real capital and creates money which has no underlying value. If the growth of fractional lending was tied to growth in U.S. income levels that might work to insure that fractional lending does not finance future irrational asset bubbles.

Unfortuneately, it cannot. Equity in housing must be destroyed because in the long run an asset representing such a large portion of the U.S. economy can only grow in value at the pace of U.S. income growth. Housing has been growing 6% annually as an average since Reagan. This has been financed by artificial low interest rates set by Fed. The trouble is the curves have diverged so far now that even a 30 year mortgage can't create enough money for the average citizen to buy a home. The curve must be allowed to correct back to the historical line of U.S. income growth so homes are affordable again to the average citizen.

Actually, Bill(s), the issue is mortgages. In the end the dirivatives are just collection vehicles for the payment streams on the underlying mortgages. When the existing mortgages go bad, the payment streams go bad, the dirivatives go bad. The real trouble is the 30-1 leverage. When you are that leveraged, even a tiny bit of mortgages going bad is enough to hurt. The banks and brokerages deluded themselves with the fancy thought that real estate never goes down in value so they absolutely stuffed their balance sheets - or should I say "off balance sheets" - with massive quantities of the golden geese and never before-seen leverage levels. It all worked great until their greed got to them - and desiring even more golden eggs - they killed the goose - started inflating home prices by fixing appraisals, and selling those over-priced homes to people without incomes, whose sole intent was to flip it to the next person a couple months later on another overinflated appraisal. I have seen this first hand. My brother, unemployed at the time, received a loan when he "stated" he was making $100,000 per year. He received a great interest rate, and luckily he was borrowing only $100,000 to buy a fixer-upper, so his wife's income can sustain it, but what about the millions of unemployed or underemployed people just like him who got mortgages based on fairy tales and lies? The issue here is definetely mortgages and irresponsible greedy banks run by incompetent nincompoops.

The mortage dirivatives the government is purchasing could be good investments, it just depends on what they are paying for them. If the government is borrowing these mortgages at some level they have derived as current asset value, that is a problem. The housing equity market still has another 25% to correct before it returns to historical norms. As it continues to correct we will see greater numbers of people walking away from their fraudulently overpriced mortgages and giving the keys to the banks. Similar to the way the banks have been trying to walk away from their Clear Channel loan committments. Why should individuals be held to a higher standard. It is really just a business decision, not so much a moral one. Anyway, back to the issue, I hope the government is taking on these risks at an appropriate firesale price that will allow for at least 25% further home price deflation and the attending mortgage defaults before it might start looking bad for them. Hopefully they are allowing a wide gap - room for up to 50% deflation - to insure this does not become a taxpayer burden.

Here we have the fundamental issue. Dirivatives are harmful because they disconnect the lender from the consequences of shoddy loan underwriting. This wouldn't be such a problem for the banks except the regulators told them this stuff was too toxic to sell to Main Street investors, so the banks started selling it to towns in Norway, indirectly feeding it to Main Street by selling it to pension plans through hedge funds, and as the bubble accelerated and they couldn't find enough buyers - they started to eat their own vomit through off balance sheet SIVs. The issue is that the lender must be held to account for shoddy lending, otherwise, the lender gets greedy and starts borrowing the cheaper money in the short term markets and lending it long term - which always creates a default led credit crunch.

Nathan
With respect, IMO, you are confusing "a problem" with "the problem". I agree that "a" big problem is problem mortgages.

However, back to the original issue, the Bear transaction... "The" problem the fed and others are trying to solve is to somehow sidestep a dropping of Bear's $2.5T of CDS's on the heads of ... us. (It has nothing to do with a Bear "bailout").

For what credit defaults are these swaps for? Ya, mostly mortgage income streams, I agree. Also other stuff. Does anyone really have a handle on it?

There are <not> $45T of mortgages, securitized or not, out there. There <are> $45T of CDS's. The CDS's are out of control, wereas the mortgages may or may not be and in any case their potential damage to the real banking system is at most (from what I can tell) $1T notional.

CDS's are part of the shadow banking system which is on shaky ground now. No one knows what will happen if the shadow banking system collapses. Want to find out?

Bill

Frankly Bill, I would like to find out. That may be naive, but I have very little debt and would likely benefit from deflation with my current investments. It may be hard on a lot of people, but since it is inevitable it should be allowed to happen. The current finance system, with unlimited fractional lending and expansion of the money supply, is unsustainable. Major portions of the economy - such as housing, government, education, and medical - have been allowed to expand at double and triple the rate of U.S. income inflation. This is unsustainable, but it has been allowed to happen for 20 years until it has reached a break point and is ripe for contraction to the historical mean. If it takes the collapse of the shadow banking system to facilitate the rationalization of asset prices, then bring it on. There is no point trying to sustain a system in reality that does not function on paper.