Servias Ministries Blog

For the purpose of this discussion, there are three levels of understanding in the universe-

1. Cause (highest level of understanding, divine understanding)

2. Cause and effect (structural understanding or men’s understanding)

3. Effect (survival- without understanding)

Effect-

When we are born into this world we have little or no understanding of cause and effect.  We simply respond to stimuli.  When we are hungry, we cry.  When we have soiled diapers, we cry.  When those issues are removed, we quit crying… usually.  As we grow, we begin to understand the significance of "cause and effect" in some areas.  In the areas of immaturity, adults still only understand effect.  In the financial realm, 50 year old couples will make poor financial decisions because they don’t understand "cause and effect".  They are still in the "effect" category.  Investors in this category are gambling.  Effect is "time bound".

Cause and Effect-

Most adults understand the structure of the universe which operates in the "cause and effect" realm.  Physical laws are in place to assure us that the same effect happens each time certain events occur.  Chemical reactions occur consistently throughout the earth.  The seasons occur each and every year without man’s intervention.  Structure is persistent in maintaining the "cause and effect" dynamic.  However, structure decays but its building blocks do not.  Most men spend their lives within the level of understanding.  Most investors invest their money based on "cause and effect" understanding.  This is where risk resides.  "Cause and effect" are time bound.

Cause-

In the beginning God created the heaven and the earth.  "Cause" resides with Our Heavenly Father.  HE created structure and "cause and effect".  HE created the laws of physics, the mathematical truths, and the consistent responses of all "God particles", the building blocks of atoms. Men are just now beginning to comprehend the subatomic structures of atoms.  (See http://en.wikipedia.org/wiki/Higgs_boson)  This highest realm of cause supercedes the realm of "cause and effect".  It is above men’s understanding and we only gain understanding by revelation from Our Heavenly Father.  "Cause" works outside the limitation of time.

Jesus pointed us to this realm of "Cause".  He gave us a critical commandment:  Mat 22:37 Jesus said unto him, Thou shalt love the Lord thy God with all thy heart, and with all thy soul, and with all thy mind.  God is love.  That is the highest realm we can live in.  Love defies cause and effect.  It is a higher level than "cause and effect".  This is where GOD’S grace and mercy reside.  HIS grace and mercy supercede the "effect".  How many times has His mercy pulled us from the deserved "effect" of our actions?

We have a tendency to only structurally define GOD and HIS actions.  We consistently look for formulas to predict what HE will do next.  If we could only find the Holy Grail formula to predict the future.  This is EXACTLY what investors are searching for.  There are countless technical indicators and formulas used by the investment population today.  With the advent of PC’s and computing power, technical analysis of the stock market is a huge industry and preferred methodology.  The demise of the current environment is being facilitated by man’s attempt to find the master formula of successful investing.

Warren Buffet is called "The Oracle of Omaha".  People flock to Buffet hoping to get a revelation of  the perfect investment.  An oracle is a person or agency considered to be a source of wise counsel or prophetic opinion; an infallible authority, usually spiritual in nature.  Men know there is a higher power.  If only they could tap into that higher power for the next stock tip.

At 5:00 A.M Friday, October 16th, 1987,  The LORD awakened me and told me to buy $25,000 of IBM Puts (a time-sensitive, leveraged derivative of the stock with the expectation of the stock value declining).  We had the cash but not much more.  I thought it was the devil attempting to extract what funds we did have.  I was 36 years old at the time.  HE had done the same thing a few months earlier but only $2,000 was involved and it was successful.  I did not have the confidence that I had "heard" the LORD.  I did nothing.  Black Monday is the name given to Monday, October 19, 1987, when stock markets around the world crashed, shedding a huge value in a very short period.  That night on CNN Lou Dobbs commented with the following example, "if you had invested $25,000 in IBM Puts on Friday the 16th, they would be worth $1.2 million tonight.  What a lesson!

Mat 6:19-21 Lay not up for yourselves treasures upon earth, where moth and rust doth corrupt, and where thieves break through and steal: But lay up for yourselves treasures in heaven, where neither moth nor rust doth corrupt, and where thieves do not break through nor steal: For where your treasure is, there will your heart be also.

Jesus was redirecting our focus to being in Our Heavenly Father’s presence and love, that is where the revelation is.  Entering our prayer closets is where each of our gifts and callings will flourish.  When we hear The Father’s voice, we will recognize it and respond accordingly.  Our investment in time, money, or any other resource will be guided by revelation and not by risk.  We will be given the tools to carry out our calling… simply!

The following provides us a picture of the complexities of the financial market now being dealt with.  The world was warned in 1998 of the current crisis scenario as explained below.  This equates to the Hezekiah Factor of a 10 year delay.  As you read this summary, it is more important to understand the big picture than the details of the tangled web of men’s understanding.  Rather than seeking the Wisdom from above, men created formulas which appeared to be right in their own eyes.

2Ki 20:10 And Hezekiah answered, It is a light thing for the shadow to go down ten degrees: nay, but let the shadow return backward ten degrees.

Let’s begin:

The multi-trillion dollar US-centric securitization fiasco began to unwind in June 2007 with the liquidity crisis in two hedge funds owned by Bear Stearns, one of the world’s largest and most successful investment banks. The funds were heavily invested in sub-prime mortgage securities. The damage soon spread across the Atlantic to a little-known German state-owned bank, IKB. In July 2007, IKB’s wholly-owned subsidiary, Rhineland Funding, had approximately €20 billion of Asset Backed Commercial Paper (ABCP). In mid-July, investors refused to rollover part of Rhineland Funding’s ABCP. That forced the European Central Bank to inject record volumes of liquidity into the market to keep the banking system liquid.  The intervention of KfW, rather than stopping the panic, led to hoarding of reserves and to a run on all commercial paper issued by international banks’ off-books Structured Investment Vehicles (SIVs).  Asset Backed Commercial Paper was one of the big products of the asset securitization revolution promoted by Alan Greenspan and the US financial establishment. They were the stand-alone creations of the major banks, set up to get risk off the bank’s balance sheet. (You may not understand the details, be assured that most of those making the decisions affecting the U.S. don’t either.)

A structured investment vehicle (SIV) is a fund which borrows money by issuing short-term securities at low interest and then lends that money by buying long-term securities at higher interest, making a profit for investors from the difference.

The risk that arises from the transaction is twofold. First, the solvency of the SIV may be at risk if the value of the long-term security that the SIV has bought falls below that of the short-term securities that the SIV has sold. Second, there is a liquidity risk, as the SIV borrows short term and invests long term; i.e., out-payments become due before the in-payments are due. Unless the borrower can refinance short-term at favorable rates, he may be forced to sell the asset into a depressed market.

In the case of IKB in Germany , the cash flow was supposed to come from its portfolio of sub-prime US home mortgages, mortgage backed Collateralized Debt Obligations (CDOs). The main risk faced by investors was asset deterioration—that the individual loans making up the security default—precisely what began to cascade through the US mortgage markets during the summer of 2007.

The problem with CDOs was that once issued, they were rarely traded. Their value, rather than being market-driven, were based on complicated theoretical models.

When CDO holders around the world last summer suddenly and urgently needed liquidity to face the market sell-off, they found the market value of their CDOs was far below book value. So, instead of generating liquidity by selling CDOs, they sold high-quality liquid blue chip stocks, government bonds, precious metals.

That simply meant the CDO crisis led to a loss of value in both CDOs and stocks. The drop in price of equities triggered contagion to hedge funds. That dramatic price collapse wasn’t predicted by the theoretical models built into quantitative hedge funds and led to large losses in that part of the market, led by Bear Stearns’ two in-house hedge funds. Major losses by leading hedge funds further fed increasing uncertainty and amplified the crisis.

That was the beginning of colossal collateral damage. The models all broke down.

Lack of transparency was at the root of the crisis that had finally and inevitably erupted in mid-2007. That lack of transparency was due to the fact that instead of spreading risk in a transparent way as foreseen by accepted economic theory, market operators chose ways to “securitize” risky assets by promoting high-yielding, high-risk assets, without clearly marking their risk. Additionally, credit-rating agencies turned a blind eye to the inherent risks of the products. The fact that they were rarely traded meant even the approximate value of these structured financial products was not known.

Ignoring lessons from Long Term Capital Management (LTCM)

With that collapse of confidence among banks in the international inter-bank market, the heart of global banking and which trades in Asset Backed Commercial Paper, the banking system stared a systemic crisis in the face. A crisis now threatened of a domino collapse of banks akin to that in Europe in 1931, when the French banks for political reasons pulled the plug on the Austrian institutions. Greenspan’s New Finance was at the heart of the new instability. It was his Age of Turbulence, to parody the title of his ghost-written autobiography.

The world financial system had faced a systemic crisis threat as recently as the September 1998 collapse of the Long-Term Capital Management (LTCM) hedge fund in Greenwich , Connecticut . Only extraordinary coordinated central bank intervention then, led by Greenspan’s US Federal Reserve, prevented a global meltdown.  That LTCM crisis contained the answer of all that is going wrong with the multi-trillion dollar asset securitization markets today. Curiously, Greenspan and others in positions of responsibility failed to take those lessons to heart.

The nominal trigger of the LTCM crisis was an event not foreseen in the hedge fund’s risk model. Its investment strategies were based on what they felt was a predictable mild range of volatility in foreign currencies and bonds based on data from historical trading experience. When Russia declared it was devaluing its rouble currency and defaulting on its Russian state bonds, the risk parameters of LTCM’s risk models were literally blown out of the water, and LTCM with it. Sovereign debt default was an event that was not “normal.”

Unlike the risk assumptions of every risk model used by Wall Street, the real world was also not normal, but rather highly unpredictable.

To cover their losses LTCM and its banks began a panic sell-off of anything it could liquidate, triggering panic selling by other hedge funds and banks to cover exposed positions. In response, the US stock market dropped 20%, while European markets fell 35%. Investors sought safety in US Treasury bonds, causing interest rates to drop by over a full point. As a result, LTCM’s highly leveraged investments started to crumble. By the end of August 1998, it lost 50% of the value of its capital investments.

In the summer of 1997 amid the hedge fund-led attacks on the vulnerable currencies of Thailand , Indonesia , Malaysia and other Asian high-growth “Tiger” economies, Malaysia ‘s Prime Minister Mahathir Mohamad openly called for greater international control on the murky speculation of hedge funds. He named the name of one of the largest involved in the Asian attacks, George Soros’ Quantum Fund. Because of US pressure from the Treasury Department by Secretary Robert Rubin, the former head of Goldman Sachs, and from the Greenspan Fed, no oversight of opaque offshore hedge funds was ever undertaken. Instead they were let to grow into funds holding more than $1.4 trillion in assets by 2007.

Fatally flawed risk models

The point about that LTCM crisis that rocked the foundations of the global finance system, was who was involved and what economic assumptions they used—the very same fundamental assumptions used to construct the deadly-flawed risk models of the asset securitization debacle.

At the beginning of 1998, LTCM had capital of $4.8 billion, a portfolio of $200 billion, built from its borrowing capacity or credit lines loaned from all the major US and European banks hungry for untold gains from the successful fund. LTCM held derivatives with a notional value of $1,250 billion. That is one unregulated, offshore hedge fund held a portfolio of options and other financial derivatives nominally worth one and a quarter trillion dollars. Nothing of that scale had ever before been dreamed of. The dream rapidly turned into a nightmare.

The major global banks who had poured their money into LTCM hoping to coattail the success and staggering profits included Bankers Trust, Barclays, Chase, Deutsche Bank, Union Bank of Switzerland, Salomon Smith Barney, J.P.Morgan, Goldman Sachs, Merrill Lynch, Crédit Suisse, First Boston, Morgan Stanley Dean Witter; Société Générale; Crédit Agricole; Paribas, Lehman Brothers. Those were the very banks that were to emerge less than a decade later at the heart of the securitization crisis in 2007.

Speaking to press at the time, US Treasury Secretary Rubin declared, “LTCM was a single isolated instance in which the judgment was made by the Federal Reserve Bank of New York that there were possible systemic implications of a failure, and what they did was to organize or bring together a group of private sector institutions which then made a judgment of what was in their economic self interest."

The source of the awe over LTCM was the “dream team” who ran it. The fund’s CEO and founder was John Meriwether, a legendary trader who had left Salomon Brothers following a scandal over purchase of US Treasury bonds. That hadn’t dented his confidence. Asked whether he believed in efficient markets, he once modestly replied, "I MAKE them efficient." The fund’s principal shareholders included the two eminent experts in the "science" of risk, Myron Scholes and Robert Merton. Scholes and Merton had been awarded the Nobel Prize for economics in 1997 for their work on derivatives by the Swedish Academy of Sciences. LTCM also had a dazzling array of professors of finance, doctors of mathematics and physics and other "rocket scientists" capable of inventing extremely complex, daring and profitable financial schemes.

Summary:

1. Long Term Capital Management was the precursor to the current financial tsunami- the warning shot.

2. Mathematical models were developed by man to attempt to analyze the behavior of investors, markets, countries, hence the universe and ultimately GOD.

3. They were wrong.

4. GOD defies mathematical definition.

5. The idols of man’s heart will rationalize anything including incorrect assumptions contained in mathematical models.

6. These idols will ultimately be the downfall of the current economic/financial system.

7. Man will turn from his wicked ways out of desperation.

8. The party is just about over.

Financial leverage: The degree to which an investor or business is utilizing borrowed money.

The last 25 years have been all about leveraging and leveraging is all about probabilities with one exception.  That exception happens with Our Heavenly Father tells you to borrow.  Borrowing is not a sin.  There are specific Scriptures relating to usury.  The borrower is subject to the lender and agrees to submit to specific terms and conditions. 

When times are good we all become optimistic about the future and its opportunities.  Along with opportunities comes expected increases in income and cash flow.  There is no end in sight.  The assumption is that asset values will always rise and if you buy a house, it will increase in value.  For many that assumption held true during their adult life.  Those that lived through the Great Depression had a reality check.  The Roaring 20’s had seen dramatic increases in asset valuations.  Life was good.  After the Stock Market Crash of ’29, the market did have days of recovery.  See the following graph:

This precipitous drop did not wipe out all stock share values.  It wiped out capital of people who had leveraged up their investments.

Excerpt of the Crash of ’29 (from http://en.wikipedia.org/wiki/Wall_Street_Crash_of_1929):

…After an amazing five-year run when the world saw the Dow Jones Industrial Average (DJIA) increase in value fivefold, prices peaked at 381.17 on September 3, 1929.  The market then fell sharply for a month, losing 17% of its value on the initial leg down. Prices then recovered more than half of the losses over the next week, only to turn back down immediately afterwards. The decline then accelerated into the so-called "Black Thursday", October 24, 1929. A record number of 12.9 million shares were traded on that day.

The crash followed a speculative boom that had taken hold in the late 1920s, which had led hundreds of thousands of Americans to invest heavily in the stock market, a significant number even borrowing money to buy more stock. By August 1929, brokers were routinely lending small investors more than 2/3 of the face value of the stocks they were buying. Over $8.5 billion was out on loan,^[26] more than the entire amount of currency circulating in the U.S.  The rising share prices encouraged more people to invest; people hoped the share prices would rise further. Speculation thus fueled further rises and created an economic bubble…

Does any of this story sound familiar?  Hedge funds leveraged their capital 30 to 1 and higher speculating that prices would climb even further.  They used complex algorithms (formulas) to determine which stock or stocks to buy, how much, and at what price.  Their formulas were correct 90-95% of the time.  We are now dealing with the 5%.

What is the impact of "de-leveraging" on good stocks?  The stock prices will be pushed down during this de-leveraging process.  Why?  In order to raise cash to cover the borrowing against bad positions, the investor must sell anything and everything, even the good, sound stocks.  Thus the selling pressure outweighs the buying pressure and the price declines.

The people that made money during the Great Depression were those who had cash and could wait for the market to bottom out and then pick up quality investments for pennies on the dollars.  Those who went into the Great Depression highly leveraged lost it all.  In despair, some jumped out of windows to their death.

In Proverbs 22:7 we are told: "The rich ruleth over the poor, and the borrower [is] servant to the lender."  In the early 1980’s the credit bubble began.  Mortgage securitization also began in earnest.  The following is the big picture:

1971  The elimination of the gold standard allowing for an unchecked increase in money supply (inflation)

1979-83  Inflation, which peaked at 13.5% in 1981, was successfully lowered to 3.2% by 1983 under Paul Volcker’s oversight at the Federal Reserve.

1983-2008  The massive credit bubble was created by providing artificially low interest rates and relaxation of lending standards (promoted by the Government.

1994  Long Term Capital Management, a hedge fund, was founded and failed.  In 1998 it lost $4.6 Billion in four month, the first example of derivatives failure.  Mathematicians used formulas to determine derivative risk probability… unsuccessfully.

In 2000, Credit Default Swaps became a tool for financial speculation when the Commodity Futures Modernization Act of 2000 specifically barred regulation of these trades.

2000-2008 Credit Default Swaps (de facto insurance of sub prime mortgage securities) were effectively endorsed by the ratings agencies who issued "AAA" ratings to toxic debt because it has Credit Default Swaps (CDS) insuring its value.  Issuers never used the term "insurance" since it would then be subject to regulation and capital requirements.  Thus if the issuer went out of business the worthless security would be re-valued at its underlying value- toxic debt.

When you borrow from the bank, you are a "servant to the lender".  However, when the bank receives deposits from a customer, they are "servants’ to the lenders (depositors).  When I deposit $1,000 into a bank, my $1,000 is carried as a liability on their books.  In turn they will typically loan about $900 of that money to a borrower.  Currently, they will charge about 7-9% and pay me 1-3%.  Effectively they make 4 to 8% interest on the loan.  The borrower will not use up all the loan so part of the money will go into his checking account.  That money goes through the same process as above and it is called "the multiplier effect".  When things are going smoothly the banks make a lot of money on "our deposits".  What would happen if I pulled out my $1,000 and bought gold or silver with it?  It is removed from the banking system and the system contracts in the reverse of the multiplier effect.  This is why the central banks around the world are suppressing the price of gold and silver.  They do not want the average depositor converting their bank deposits to gold and silver thus removing it from the credit system.  Once out of the system, it is out of their control.

You now know why the U.S. Congress included the FDIC increase from $100,000 to $250,000 in deposit insurance.  They have been told privately that there may be a "run" on the banks.

In volatile times how do you protect the wealth you have spent your entire life to attain?  There is only one store of value that has no liability attached to it- gold (or silver).  The U.S. Dollar is a Federal Reserve Note.  A Note has a liability attached to it.  Prior to Federal Reserve Notes, the U.S. Treasury issued Silver Certificates (backed by silver).  Those are gone, taken out of circulation intentionally.

Executive Order 11110 was issued by President John F. Kennedy on June 4, 1963.  The Order was for the Treasury to issue silver certificates against all silver held by the government which did not already have certificates against it. The Order was needed due to the passage of Public Law 88-36 which repealed the Silver Purchase Act and other related monetary measures. One result was that after the repeals, only the President could issue new silver certificates.  The Federal Reserve System could replace the certificates, but only in larger denominations. The thrust of the Order returned the authority to issue new silver certificates (and specify denominations) back to the U.S. Treasury.  He plan to issue $4.3 Billion which would have replaced the demand for Federal Reserve Notes and take back control of the nation’s currency.

Kennedy was assassinated on November 22, 1963.  After Mr. Kennedy was assassinated just five months later, no more silver certificates were issued.

I recommend each family keep at least one to two month’s expenses in cash.  If the large depositors (over $250,000) decide to move their money away from the U.S. banking system, a bank holiday (temporary closing of all banks) could be proclaimed until the leaders could figure out what to do about the crisis.  Will it happen?  Only Our Heavenly Father knows.  If it does happen we must be prepared.  Until these volatile times have passed, cash in hand is "king.  You can always redeposit the cash after the crisis window has passed.

…and you will know the truth, and the truth will set you free…

What is truth?  It is that candor of mind which is free from affection, pretence, simulation, falsehood, and/or deceit in any matter under consideration.

The moment Paulson asked for a blank check free from any judicial review was a clear indication that the truth was hidden from view.  The complexities of this world have created a hotbed of lies.  Lies and deceit have been at the center of our financial system for years.  In 1970’s when President Nixon took us off the gold standard, he set the stage for this crisis.  Gold has no liability attached to it.  It’s value cannot be manipulated.  The Scripture talks about unequal weights and measures when conducting business.  This problem of deceit has been occurring for thousands of years.  Many of us work our entire lives to provide for our families only to have our future shattered by the lies and deceit of the financial elite and politicians.  The current system will fall just like every major kingdom has in the past.  We have all studied the endgame of these kingdoms or empires.  We know the ultimate result.  The Bible tells us of Mystery Babylon, the most subtle of all kingdoms.  It may appear somewhat invisible to many but its ugly head in now coming to light.

We are told in Revelation 17:5 that Mystery Babylon is the "mother of harlots":

Rev 17:5  And on her forehead a name was written: MYSTERY, BABYLON THE GREAT, THE MOTHER OF HARLOTS AND OF THE ABOMINATIONS OF THE EARTH.

What is a harlot?  A prostitute, a harlot, one who yields herself to defilement for the sake of gain.  Recently Paul Volcker called this financial debacle "the mother of all crises".  When a person defiles himself, he becomes "unclean" or "polluted".

Our goal is to expose and present the truth in areas of our callings.  We have no interest in swaying political leanings.  Each of us have GOD given gifts and callings.  Those callings become apparent as we grow and mature.  We are attracted to those callings as they attract us as well.  Each calling makes up a part or portion of the Body of Christ.  As we function in our individual calling, we feed the Body.  It is our hope that as we expose the truth our readers will respond accordingly and not be swept up in the lies.

This financial crisis is exposing the truth.  The genie is out of the bottle.  Congress changed the wording from a bailout plan to a "rescue" plan hoping to make it more palatable to the American people.  Let’s just put lipstick on that pig!  Our readers have been warned of this financial tsunami for some time.  Is it too late do protect your individual family?  No.  One of the aspects of this crisis is the lie being promoted about the value of gold and silver.  The prices of these metals have been manipulated and held down.  I believe the true current value of gold should be in the $2,500 – $3,500 range if compared to the U.S. balance sheet.  Silver should be at the $50+ level.  The physical metal is in short supply but the "paper" market would have you believe there is plenty of supply.  It is all about deceit.  It is all about covering up the truth in hopes of continuing the transfer of wealth away from those who earned it honestly.

Are we about to see a hailstorm and flood?

Isa 28:17  Also I will make justice the measuring line, And righteousness the plummet; The hail will sweep away the refuge of lies, And the waters will overflow the hiding place.

Is the financial flood ready to come?  Lamech (in the Scripture) lived 777 years.  He was Noah’s dad.  Plastered all over the New England newspapers was the number- 777.  With over one quadrillion dollars in outstanding derivatves (1,000,000,000,000,000), the global financial system is a house of cards and  people are scared.  The problem wasn’t "newsworthy" years ago as it was building.  Those of you who attended the Tabernacles meeting in Phoenix a few years ago heard me speak of the upcoming financial tsunami.  This week, four European banks were saved and there are more to come.  European banks tend to be secretive about their affairs until the last minute. See: http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3104666/Banking-crash-hits-Europe-as-ECB-loses-traction.html

Nine years ago yesterday, the NY Times published an article that documented the origins of the sub-prime mortgage crisis.  Bill Clinton’s Administration put pressure on the banking industry to expand mortgage loans among low and moderate income people, specifically mentioned is Fannie Mae.  Fannie Mae had already lowered down payment requirements in order to expand its revenue and profits. See: http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260

Franklin D. Raines, the former CEO of Fannie Mae served as White House budget director under President Bill Clinton prior to his job at Fannie Mae.  What a tangled web they weave.

The financial bailout will not bail out anything, it’s only a band aid.  The scare tactics presented by Paulson focused on our "retirement accounts".  Remember when a change in laws promoted the IRA/401K programs which allowed companies to move away from a defined benefit retirement plan?  The U.S. politicians have systematically placed the American people and global community in harm’s way.  The Federal Reserve lowered interest rates to artificial lows.  This act helped the borrowers and hurt the savers.  The generation who lived through the Great Depression are mainly found among the group of savers.  They knew what it was like to have no money.  They had to hoard anything that might be of use in the future.  Many of those who lived in the Great Depression are dying off now.  They were like a compass to remind us of how hard times could be.  Could we be entering into a Greater Great Depression?  By injecting huge amounts of new money into the financial system our retirement accounts will suffer anyway.  Why devalue our retirement account any more than it already is?

The same people who got us into this mess want to use our money to bail us (them) out!  Every senior executive in the financial industry who received bonuses in the last nine years should write a check and return every dime.  Not gonna happen!  Maybe it’s time to get into the Ark!

If you think $700 billion is enough to resolve the financial crisis, you are sadly mistaken.  The government’s estimate is the initial payment to start dealing with the flawed financial business model.  The underlying derivatives will be observed by all of us to truly be financial weapons of mass destruction.  Washington Mutual, a 119 year old company with $307 billion in assets, is by far the biggest bank failure in history.  Stockholders and most bondholders will lose their entire investment.  WaMu participated in a substantial number of credit default swap instruments.  The counterparties will be forced to take a loss against their capital structure. 

What is a credit default swap? 

A credit default swap (CDS) is a credit derivative contract between two counterparties, whereby the "buyer" or "fixed rate payer" pays periodic payments to the "seller" or "floating rate payer" in exchange for the right to a payoff if there is a default^[1] or "credit event" in respect of a third party or "reference entity".

If a credit event occurs, the typical contract either settles by delivery by the buyer to the seller of a (usually defaulted) debt obligation of the reference entity against a payment by the seller of the par value ("physical settlement") or the seller pays the buyer the difference between the par value and the market price of a specified debt obligation, typically determined in an auction ("cash settlement").

A credit default swap resembles an insurance policy, as it can be used by a debt holder to hedge, or insure against a default under the debt instrument. However, because there is no requirement to actually hold any asset or suffer a loss, a credit default swap can also be used for speculative purposes and it is not generally considered insurance for regulatory purposes.

What happens if the "insurer" cannot perform?  The underlying asset becomes worth less.  If the holder of the asset is required to "write down" the value of the asset, it is a direct hit against the capital of the the counterparty.  It can create insolvency and it will do so to many smaller counterparties and hedge funds.  Nobody knows the impact of the failure of WaMu and that is why Treasury Secretary Paulson wants a "blank check" from Congress.

If we could get a transparent audit of all the losses resulting from this crisis, I believe the total will be between $4 Trillion and $25 Trillion, if not more.  It will get ugly soon.  There is no way out because the current decision makers know no other paradigm.  The current system feeds upon itself and by definition protects and perpetuates itself.  Interest rates have been lowered to allow these very institutions to re-liquify by transferring the wealth of savers to the financial institution’s balance sheet.

A new business model based on love will be necessary to resolve this crisis.  The current greed-based model will fail soon.

Inflation is defined as an increase in money supply.  Price inflation results after the money supply has been increased.  The U.S. Government wants us to focus on price inflation rather than true inflation of the money supply.  Remember when the Fed quit publishing M3 Money Supply increases?  They said it cost too much money to publish.  Give me a break!  They print the stuff.  This was as of March 23rd, 2006.  They knew they had problems then.

The graph below depicts the growth of the U.S. Money Supply- M3.  M3 is the broadest and most complete measure of the overall money supply of the United States.  It is the best overall indicator of inflation and expected price inflation.

We are about 1/3 of the way through the crisis.  Hank Paulson needs some more money to fix the problem.  Let’s see what will push the value of the U.S. Dollar down and the relative value of gold up:

1. Fed’s discount window: $33bn balance

2. Expansion of temporary swap lines with central banks: $180bn

3. Fed loans through the Primary Dealer Credit Facility: $20bn through sep 17

4. Treasury purchase of GSE MBS (Mortgage-Backed Securities) this month: $10bn

5. Potential cost of Fannie/Freddie bailout: $200-$300bn

6. Loan to AIG: $85bn

7. Treasury buying mortgage-related assets: $700bn – $1,500bn

8. Potential supplementary stimulus package favored by Democrats: $100bn

9. Insuring money market funds: $50bn

10. Treasury fortifying the Fed’s balance sheet: $100bn

11. Treasury fortifying the FDIC’s balance sheet: $150bn+ (799 financial institutions are suspect now)

12. Fed purchase of agency discount notes & ABCP(Asset-Backed Commercial Paper): amount not specified

Total $1.7 Trillion to $2.5 Trillion

"A trillion here, a trillion there… before long, you’re talkin’ real money!

Many of us who have been around for a while know that when Washington says $700 Billion, they really mean $1.4 to $2.1 Trillion.  Over the weekend, King Henry (Hank Paulson) spoke on the networks about the need to shore up the financial system.  He focused on the impact to the average American, not the real beneficiaries- the banks.  Most of Paulson’s career was spent at Goldman Sachs.  His wealth was created during this time.  He is comfortable operating in this paradigm.  His net worth is reported to be $700 million.  (http://en.wikipedia.org/wiki/Henry_Paulson)

Paulson is shrewd.  His compensation package at Goldman Sachs was reported to be $37 million in 2005.  Wasn’t that in the midst of this sub-prime and derivative debacle?  Hmmm!  How can we expect a man who profited from the era of greed to oversee the cleanup?  In his request to Congress, he added that there would be no action subject to Court review.  What does this mean?  It sounds like a "get out of jail" card for all of his former (or current) associates.  Congress is being pressured to pass a bill immediately.  They have been told "there is no time".

"If financial conditions fail to improve for a protracted period, the implications for the broader economy could be quite adverse," Bernanke said in his prepared statement for the Senate Banking Committee panel.

"We must do so in order to avoid a continuing series of financial institution failures and frozen credit markets that threaten the well-being of American families’ financial well-being, the viability of businesses both small and large and the very health of our economy," Paulson said.

On the FBI’s Fraud Prevention Web Page, the telemarketing ploy to get your money uses the phrase: "You must act ‘now’ or the offer won’t be good."  Does this sound familiar?  This storm has been brewing for months and years.  This website has been warning individuals to prepare themselves for the financial crisis for nearly a year yet Congress has only days to pass a bill that will surely have a negative impact on every American and many in other countries.  I guess you should have urged your Congressman to read our website.

Paulson fully participated in the game of greed.  Some of his $700 million came from the results of working deals in the derivatives and sub-prime instruments.  Once Americans are fully briefed on the new law, they will be outraged.  Bernanke and company have only one way to pay for this new liability- hyper-inflate the U.S. Dollar.  What will this mean?  Higher commodity prices and higher inflation.  Oil and gold both spiked up on news of the bailout.  Why?  Big money understands the impact.  The average Joe does not.  How do you like the language in the draft:

"Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency," the original draft of the proposed bill says.  It goes on to say, "Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure."

America’s greed is placing unbearable weight on the current economic system.  This is no different than the societies of the past.  The insatiable appetite for "more" is self destructive.  If you have a net worth of $700 million, what else do you need?  Another $100 million!  Mankind continues to operate with logic rather than the heart.  Logic tells you to keep this complex system afloat.  The heart would tell you to simplify.  The financial institutions created an unbelievably complex environment that defies understanding.  AIG was saved because it is too big to fail.  I would suggest that it is too complex to fail.  Nobody in Washington or New York could effectively determine the outcome of the bankruptcy of AIG.  Therefore it was too risky to let it fail.

Paulson and Congress want to include just about any debt of any institution in the bailout.  However I doubt that you and I will have access to any of that money.  They will put plenty of spin on the bailout to make it palatable to the American public.  After all, it’s election time.

The perfect storm has three fronts.  We are now in the midst of the derivatives storm.  Let’s not forget storm #2, Peak oil, or storm #3, the unfunded liabilities  associated with the baby boomers that are moving toward retirement!

Get out of debt, simplify, and most of all…. pray!

For nearly a year I have been warning readers of the coming financial storm.  It is here!  Pundits have told us many times "the worst is over".  That is not the case.  We are still at the front end of the mortgage crisis.  There are still many mortgage loans that have not yet reset.  The recent demise of Lehman Brothers investment bank will take months to unwind.  This domino is very significant.  When the derivative instruments are fully cashed out, the counter-parties will take a big hit.

Was Lehman too big to fail?  Nobody knows.  Their bankruptcy is a huge risk to the global financial system.  The greed of the last five years has come home to roost.  All of the exorbitant bonuses collected by greedy financiers should be sought by the courts, and they probably will be.  Securitizing  a heap of junk and calling it "AAA" was the epitome of fraud by the banks as well as the ratings agencies.  The regulators looked the other way as well.  The Federal Reserve and U.S. Treasury have no experience to deal with a disaster of this magnitude.  They are simply guessing and that is scary!

There has been an orchestrated attempt during this crisis to knock down the commodities including gold and silver.  Gold is the barometer of the perceived status of the fiat financial system.  Gold has no underlying liability attached to it.  Historically when fiat currencies head south, investors move to gold thus moving its relative price upward.  Central banks and their "agents" have been battering gold for the last several months in attempt to manipulate the market’s perception that "all is well".  How much longer will they attempt to do this?  Certainly through the U.S. election just 49 days away. 

The fundamentals of the precious metals suggest that they will be significantly higher soon.  This is the time to acquire real insurance- gold and silver.  Headline inflation exceeds personal savings rates.  This means your U.S. Dollars are slowing losing buying power.  This could escalate.  Stocks are at risk due to the unwinding of the financial instruments of mass destruction.  What are we to do?  One must keep liquid to pay the bills.  Gold will be here one month from now.  Your financial institution may not.

Humpty Dumpty sat on a wall,
Humpty Dumpty had a great fall.
All the King’s horses, And all the King’s men
Couldn’t put Humpty together again!

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