Saturday, September 27, 2008

The Mother of All Bailouts

It's unfathomable to most Americans to comprehend the cause and effect of this nation's greatest financial crisis, since the Great Depression. The amount of dollars that it could take to head off a potential collapse of our financial system is unknowable. It may require a trillion or even two. One thing is certain, however; we are all witnessing the beginning of the end of a global, over leveraged, fiat (paper) money system and the possible demise of the US dollar.

I finished writing GREED at the end of the year 2007. I new at that time, as prominent a place as the "subprime mess" was occupied in the media, that it was the "highly leveraged derivative scheme (which I improperly termed the ‘daisy chain') that was the major threat to the world's financial system. (It was Warren Buffett who called derivatives, weapons of financial mass destruction.) Spot on. It is the collapse of this inverted pyramid that has brought the global financial markets to its knees.

Readers of my book will recall (page 93) an episode that occurred exactly a decade ago which was the poster child of things to come. Robert Merton and Myron Scholes won the Nobel Prize in economic sciences for a "Black Fox" system of using derivatives later utilized at their company Long Term Capital Management (LTCM) that would produce outsized gains while at the same time, minimize risk. In September 1998 (when Russia defaulted on its sovereign debt) the fund lost billions in a matter of days and created a Wall Street panic. A crisis was averted when a government-initiated Wall Street funded bailout saved the day. The concept of moral hazzard (bail out by Uncle Sam) worked so well on a small scale, Wall Street took it to an unknowable level ($300-$400 Trillion dollars) in the next decade. So Wall Street greed conveniently forgets its sins of the past. Is that the story? No. Here's what you don't know.

After the LTCM fiasco of 1998, there was (as always) a mission by Congress to investigate and regulate the derivative market. The strongest advocate and defender of the continued use of these super-sophisticated contracts (which means few knew what they were) was none other than Alan Greenspan (the "Emperor who had no clothes"). To assure that the inverted pyramid scheme would continue unregulated, Senator Phil Gramm (R-Texas), on December 15, 2000 just hours prior to Congress adjourning for the Christmas break, slipped an amendment into the appropriations bill. This cleverly-timed amendment forbade federal agencies to regulate financial derivatives that would open the door for the creation of the subprime mortgage-backed securities and other super leveraged paper contracts. And, that's not the end of this sordid story.

Senator Gramm's other contribution to the financial crisis was the "Enron Loophole" which prevented federal oversight of Enron's electronic energy trading which of course resulted in devastating losses to the employees and shareholders of that company. According to Ms. Froma Harrop of The Providence Journal, Enron's CEO Ken Lay chaired Gramm's 1992 re-election campaign and his wife Wendy Gramm, severed on Enron's Board earning as much as $1.8 million.

What lessons are to be learned?

Be circumspect of all legislation passed just prior to Congressional recess. Remember, the Federal Reserve Act of 1913 was passed at the same opportune moment when barely a quorum was present which transferred control of America's banking system to a private cabal. Today's crisis can be traced back to that fateful day, almost 100 years ago.

Secondly, this entire crisis and the necessity for The Mother Of All Bailouts is a by-product of a dereliction of duty by our nation's leadership and the ethical impairment of Wall Street. Our political and financial leaders are all member of the "good ole' boys club" whose credo is "do onto ourselves before we do onto others." I never thought I would live long enough to declare that our government is corrupt at its core! The system is broke and broken.

The central theme of GREED is that we will survive this crisis and there will be an inflationary boom, possibly hyper-inflationary. This unknowable amount of money infused into our financial system virtually guarantees that obscene inflation lies dead ahead. Re-read pages 3 to 5 of GREED that describes the inflationary boom from 1976 to 1980. Enormous profits were made during this period but when the boom ended in 1980 (16% long term mortgage rates and 21.5% prime rate) rapid asset deflation ensued.

We are all (except the CEO's with golden parachutes) experiencing the aftermath of GREED. Sweeping powers will be granted to those who led us to this abyss, markets will no longer be free and most Americans will be left to their own devices. My fervent hope is that I can bring some light into this darkness.


Hal said...

Just wanted to let you know I am enjoying your written and video blogs, please keep them up as it looks like your book has been dead on so far.
-Hal Feinberg

Anonymous said...

HL - I enjoyed your book and coincidentally live in your neck of the woods - 32nd St/Camelback area. I agree with you, gigantic inflation is upcoming without question. Would you mind discussing some of the things you are doing, personally, to prepare for such an event? Thanks again!!

Matt said...

Excellent blog and even better book! Inflation is coming and I think real estate is the place to hide. With prices so low, the inventory, according to, is starting to fall (particularly in Arizona). Keep up the great work!