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The television show mentioned above takes place in New York City.  NYC is a vibrant, never sleeping city known as the financial center of the universe.  The waters around the city are shark-infested.  No, not those from the Animal Kingdom Phylum Class Order Family Genus Species, Animalia Chordata Chondrichthyes, this group is from the legalis attorneyicum class.  The lawyers are ready "to roll" in this derivative crisis.  New York City is suing Countrywide, Officers, and Underwriters. See http://www.reuters.com/article/businessNews/idUSN2536805820080125?feedType=RSS&feedName=businessNews

The executives of the company cashed out with bonuses of over $700 million.  As I wrote in a previous blog many pension funds can only invest in "investment grade" securities.  The ratings agencies define "investment grade" based on the data and information presented to them.  You can be sure that there will be a multitude of fingers pointing everywhere.  Individuals will "plead out" early in order to minimize the impact to their personal lives.  This lawsuit is just the tip of the iceberg.  There will be many more lawsuits to come.  The lawyers will be the winners.  Countrywide will lose, the pension fund will lose, Countrywide stockholders will lose,…

Greed produced this debacle.  Perception displaced reality among the lenders, underwriters, regulators, stockholders, Congress, and the Fed.  The rich and famous went for a joyride with our hard earned money.  In the end, the global taxpayer will pay for the ride.  If we run out of money, which is possible, there will be a calamity of Biblical proportions.  The people who have been running the monetary system are nearly out of tricks.  The courts will be busy for years to come.  The recent surprise rate cut was in response to the volatility of the the world markets.  The U.S. economy has been the economic juggernaut over the last sixty years.  Interest rate declines are inflationary and negative to the value of the U.S. Dollar.  Gold and silver will continue their climb to $1,600/$50 and beyond.  Inflation is the silent killer of the elderly’s savings.  The bigger the problem, the greater the cleansing.  Cleansing cycles are Biblical, whether is be 76 days, weeks, months, or years.  Cleansing removes the worthless and unproductive.  Pruning time is upon us.

Could Ben Bernanke, Fed Chief, be thinking, "Why didn’t I keep that job at the University?"

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/01/25/bcnswiss125.xml

When I was a Chief Financial Officer (CFO) our growth was dictated by a formula known as the "sustainable growth rate" formula.  Basically our growth was restricted by the amount of profit that was added to the retained earnings at the end of the year.  Retained earnings is a category of Owner’s Equity in the company.  Secondarily growth could be enhanced by improvement of asset turnover.  For instance, if you sold $50 million a year of inventory and kept $10 million of inventory in stock, your turnover rate is 5.  If you could reduce your inventory to $7 million and still maintain enough to satisfy customer demand, your turnover rate would exceed 7.  You would free up $3 million to help grow the business.  The sustainable growth rate formula took into account these factors in determining how fast we could expand the business.  Another factor was the debt to equity ratio.  If we had liabilities of $4 million and Owner’s Equity of $2 million, our ratio was 2.  Our bank watched these ratios as we did.  If we could increase our leverage thus expand our assets and liabilities by $4 million, then our debt to equity ratio would be 4.  Banks kept historical statistics by industry of acceptable financial ratios in order to compare the industry to our ratios.  This was the way they did business 25 years ago. It is not important for you to understand the financial terms, it is important to understand that the financial institutions have had plenty of tools to monitor their lending practices.

By relaxing credit analysis standards you accelerate expansion of the economy at an increasing rate of change- Accelerator Factor.  The sustainable growth rate formula restricted the rate of change of growth due to the consistent restriction of leverage.  What is leverage? It is the use of borrowed funds to complete an investment transaction. The higher the proportion of borrowed funds used to make the investment, the higher the leverage and the lower the proportion of equity funds.  We were restricted from growing our company too fast by over leveraging our assets.  Why is this a problem?  It is all about cash flow.  Cash pays interest expense.  Cash pays down the principal of you note to the bank.  Cash "makes" payroll.  Cash is the "oil" of the business to keep it running.  Too much investment in non-cash assets works against the ability to repay debt.

There are three types of borrowers.  The hedge borrower is one who can meet all his debt payments with cash. The second type is the speculative borrower who can meet interest payments but must constantly roll over his debt to be able to repay the original loan.  The third type of borrower is the "Ponzi" borrower; he can repay neither the interest nor the original loan. This borrower relies on the appreciation of the value of his assets to refinance their debt.  This type of borrower’s philosophy is a "greed" based philosophy.  This borrower hopes that the asset will continue to appreciate forever.  As long as his assets appreciates in excess of the original loan plus interest, he is in good shape.  This borrower wears rose colored glasses.  The sub-prime mortgage loans promoted this type of borrower.  The lending institutions virtually created Ponzi borrowers by appealing to the "greed" factor.  Why not buy a bigger house than you can afford?  The problem did not stop there.

Financial institutions allowed hedge funds to "leverage up" their assets by 20 to 30 fold in order to achieve unbelievable returns for their investors.  This avenue of lending raised the stakes of failure dramatically.  This accelerated the growth of financial instruments and funded excessive growth in various sectors of the economy.  The insatiable appetite of borrowers was welcomed by the lending institutions who threw out their "credit analysis" handbooks!  CEO’S of these institutions received large bonuses based on the yearend profit results of the institution.  Greed raised its ugly head again.  The underlying motivation of the Accelerator Factor is greed.  This motivation is the rocket fuel for the increasing rates of change in credit expansion through leverage.  However, this is a two edged sword.  The other edge is fear.

Once the market moves from greed to fear, the Accelerator Factor works in the opposite direction.  The Leverage Factor is reduced and the balance sheets shrink at an increasing rate of change.  Its like an accordion.  The Fed and other central banks are now trying to manage fear.  In the markets, fear tends to be a stronger emotion than greed, thus the ramifications of mismanaging fear on a global basis can have disastrous effects.  Since in the history of man there has not been a similar financial environment to compare, those in charge are forging new territory.  Are you ready to trust your financial future to them?

Federal Reserve Board Chairman Ben Bernanke pauses while discussing the near-term economic outlook during testimony before the House Budget Committee on Capitol Hill in Washington in this Thursday, Jan. 17, 2008 file photo. (AP Photo/Dennis Cook. File)

The underlying economic issues I’ve been writing about are gaining publicity.  The following article from The Economist explains the latest problems:

All fall down?

Jan 18th 2008 | NEW YORK
From Economist.com

Huge new problems in the capital markets?

Shutterstock

AMERICA’S big bond insurers, which have underwritten some $2.4 trillion of private and public-sector bonds, usually go about their business largely unnoticed. But now they are looking distinctly wobbly they have started to attract attention. If one or more of them were to topple over, there will be a huge knock-on effect on banks and other financial institutions that rely on their guarantees. This in turn will further worsen the credit crunch and cause an even bigger headache for policymakers already grappling with a sharp slowdown in the American economy.

The threat of such a financial domino effect looms large. Moody’s, a credit-rating agency, has signalled that it might downgrade the AAA-ratings of two of the biggest bond insurers, MBIA and Ambac, in the near future. On Friday January 18th, Ambac said that it had dropped a plan to raise $1 billion of new equity capital to preserve its rating—making futher downgrades even likelier. In response, Fitch, another rating firm, cut Ambac’s rating.

MBIA, which recently managed to raise $1 billion of new capital on top of another billion that it received from Warburg Pincus, a private-equity firm, will almost certainly need even more money if it is to preserve its AAA-rating. ACA Financial Guaranty Corporation, another insurer, is in even direr straits. In December its single-A credit rating was cut to junk status. The firm begged its trading partners to give it more time to sort out its problems. But by Friday it had still not come up with a rescue plan. The state insurance regulator of Maryland, where ACA is incorporated, has already assumed responsibility for some of its operations.

Bond insurers in effect “lend” their top-notch ratings to lower-quality debt, raising its value in the eyes of investors. Any cut in those ratings may make it impossible for the bond insurers to take on new business and would reduce the value of the securities they have already underwritten. Such cuts are now a distinct possibility because the insurers have underwritten billions of dollars of mortgage-backed securities, including those notorious collateralised-debt obligations (CDOs) that have now gone sour……

  http://www.economist.com/daily/news/displaystory.cfm?story_id=10553166 

In the Book of Daniel, The Lord gave Daniel, Hananiah, Mishael, and Azariah (Shadrach, Meshach, and Abednego) knowledge, skill, wisdom, and understanding.  The current economic problems stem from the fact that knowledge and skill were used to leverage investments against the market without wisdom and understanding.  Technical traders did not understand the fundamentals of investing and assumed that technical analysis was sufficient to beat the market returns.  The Derivative Instruments assumed theory to equal reality.  We are on the verge of a reality check!

I recently wrote about MBIA and Ambac.  As of this writing, the world markets are responding negatively concerning the subprime crisis.  Many markets lost over 5% in one day.  Volatility will continue to be the norm.  The world’s central banks are in uncharted territory.  If you are highly leveraged, reduce your leverage immediately.  Raise cash, cash is king!  If you own commodities, don’t get rid of them.  The central banks will flood the market with cash which in turn will be inflationary.  Hard assets will rise.  Food and energy costs will rise.  Brace yourself!

I sincerely believe… that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity under the name of funding is but swindling futurity on a large scale. — Thomas Jefferson

This is a lengthy and somewhat technical article.  It is not as important to understand the specific statistics as it is to get a perspective of the downward economic spiral that plagues the current economic system.  The numbers are large and history has shown that those in authority soon forget what previous generations learned.  The Great Depression was preceded by the Roaring 20’s.  The current environment has many parallel themes occurring.  The super-charged egos of those in charge believe that they can defy the compression aspect of economic cycles.  Compression is good.  Delayed compression can be life threatening.  We are currently at risk of an economic depression in the 2009-2010 time frame.  Read on…

The financial industry operates on leverage.  It loans other people’s money and collects interest income.  For instance, if you are paid 5% on your bank certificate of deposit (CD), the bank will use that money to loan out at a rate typically at least 2% higher.  The bank makes its money on the "spread" of 2%+.  Only the best customers receive the bank’s prime rate.  A standard savings account may receive 2-3% interest whereas the bank is loaning money at 7-12% interest.  The financial industry is inherently structured to make money.  The assumption of this model is that the lending and investment practices adhere to strict guidelines to insure minimal loan/investment losses.  Regulators closely monitor loan loss ratios.  They are also expected to closely review investment portfolio valuations.  This is currently where the problem lies.

SIVs are investment companies that use short-term borrowings to buy a higher-yielding asset.  When I was in banking in the 1970’s, I discovered an opportunity- borrow at 7% for 36 months and invest in 30 year Treasury Bonds at 8%.  I would simply pocket the 1% profit.  I would use the Bond as collateral.  All is good.  However I had a couple of problems.  First, I did not have the capacity to borrow much.  1% on $10,000 would only yield $100 per year, hardly worth the effort.  I would need to be able to borrow $1,000,000 to create a notable return.  Since I knew that my balance sheet would not support that kind of loan, I dismissed the opportunity.  Things have changed in the financial industry.  Hedge funds raised large amounts of money and were able to leverage their investing by 20 to 30 times.  Additionally, they could justify their investments by buying "insurance" on the asset or its stated interest rate.  What a complex arrangement!  In simple terms, the risk was spread among multiple players.  The problem is that the investment was only as good as the weakest player.  If the security was devalued, there were problems.  If the insurer became weak, there were problems.  If the bank lost money and was required to reduce its lending and thus "call" the note, there were problems.  As you can see there are many things that could go wrong in these complex transactions that base "leverage" as the underlying fuel to high returns. If the SIV invested in subprime mortgage backed securities, all of the participants would be severely impacted if the valuation of the underlying asset (houses) substantially dropped.

The housing bubble is bursting in the developed countries.  Speculators were allowed to borrow money outside the normal, historical lending criteria.  The participating banks were not innocent in this fiasco.  The mortgage lenders (equivalent to bank loan officers) were also complicit in this fraudulent activity.  Technology has provided the lending institutions with plenty of "no brainer", "fill in the blank" loan/credit analysis tools to insure safe lending practices.  Credit reporting agencies provide an easy means to verify payment history.  Once again, corporate greed has raised its ugly head and will severely impact the global financial system.  There will be many to lose their home and any savings they have accumulated.  Those marginal families will be at risk of bankruptcy.

Another bubble of equal concern is the upcoming baby boomer retirement bubble in the U.S.  The unfunded liabilities on the U.S. Government’s Balance Sheet dwarfs any potential source of revenue.  How will the U.S. be able to survive this liability?  The Federal Reserve will cut down all the trees in the country to print money.  This will be hyperinflationary.  The elderly who saved their entire lives will suffer with reduced purchasing power of their savings.  Those who are marginally surviving will become welfare recipients.  The 2007 Medicare/Medicaid insurance trust fund report reveals an unfunded liability of $40.9 Trillion on Page 190 of their latest report.  See the following link: http://www.cms.hhs.gov/ReportsTrustFunds/downloads/tr2007.pdf.  In USA Today, the overall unfunded liability to the taxpayer was $59 Trillion. http://www.usatoday.com/news/washington/2007-05-28-federal-budget_N.htm

The third bubble is peak oil.  The globe is not out oil, it is just more difficult to extract with the current, available resources.  "Peak oil" suggests that production from new discoveries no longer exceeds the production decline in output of existing fields.  The largest discovered fields around the world are in decline.  No new fields of a similar size/output have been found in decades. The world’s largest field Ghawar in Saudi Arabia was discovered in 1948 and put on stream in 1951.  With all of the technology available, oil companies have not found a larger field in the last 70 years.

The Derivative Crisis is the fourth bubble.  There are many other derivatives not tied to the subprime mortgage crisis.  In 2003, Warren Buffett warned that derivative securities were a "mega-catastrophe" and "financial weapons of mass destruction" in the annual letter to shareholders of Berkshire Hathaway, published in the Fortune Magazine:

[T]hese instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values. If, for example, you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction–with your gain or loss derived from movements in the index…

…Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one another. The troubles of one could quickly infect the others. On top of that, these dealers are owed huge amounts by nondealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems.

This derivative industry has grown into the trillions of dollars.  The Bank of International Settlements (BIS) report:

Data from the BIS Statistical Report Q4 2006
• OTC Notional Amount of Derivatives is over $414 Trillion
• 70% of Notional are Interest Rate Contracts
• Credit Default Swaps are the fastest growing product
– Over $28 Trillion
– 65% Single Name Instruments
– 35% Multi – Name Instruments

As of June, 2007 the Derivatives total stood at $516 Trillion. see: http://www.bis.org/statistics/otcder/dt1920a.pdf

Why would I put all of this information in this writing?  The average person will never hear about all of these global risks in a summary similar to the above.  The average person would not comprehend the inherent risk to his or her future that these bubbles represent.

These four bubbles combine to represent a perfect storm.  Tax hikes or other changes to the current global economy can affect the outcome, the timing, and the severity of the expected compression.  What should one do to prepare?  Reduce your leverage and borrowings.  Protect your assets from the financial institutions that may fail.  Take possession of your stock certificates (if you are fortunate to own stock).  Keep cash on hand.  Invest in gold and/or silver (hard money).  Tangible assets will ride out the storm.  People need a place to live, food to eat, and energy for heating, cooling, and transportation.  Will the severe compression take place?  A good businessman hopes for the best but plans for the worst.

What is fraud? It is "the intentional deception resulting in injury to another person."  The Scripture has several stories containing fraud.  Jacob defrauded is brother.  Laban defrauded Jacob.  The list goes on.  Typically, fraud has scarcity connected to it.  Jacob thought that Isaac’s blessing was going to Esau and there would be nothing left for him.  Fear caused him to deceive his father and injure his brother.  Where was the revelation of Love?  Love sacrifices "self" for the benefit of others.  Love knows that THE FATHER will come through no matter what the circumstances appear to be.  The perception of scarcity breeds deception.  The Scripture is full of assurances of abundance.

The sub-prime mortgage crisis may be the unraveling of the current credit system.  When a system is built on credit and perception, the tipping point of failure is akin to the "domino effect".  If a thousand dominoes are lined up together, only one critical domino will bring the thousand down.  As mentioned in an earlier writing, a financial institution’s capital structure determines its ability to loan and invest.  If the capital structure is 10% of the total balance sheet, a 10% loss or devaluation of assets wipes out its capital structure.  The result is bankruptcy.  In recent weeks, the larger investment bankers have found it necessary to search for investors to inject serious amounts of cash into their institution.  China’s Wealth Fund recently injected over $5,000,000,000 into Morgan Stanley (http://www.nytimes.com/2007/12/19/business/19cnd-morgan.html).  Morgan Stanley claimed losses of $5.7 Billion and received a cash injection of$5 Billion.

Another more subtle issue to the average person is the "insurance" or derivatives behind the credit instruments.  THE DERIVATIVE INSTRUMENT IS ONLY AS GOOD AS THE BALANCE SHEET OF THE LOSING PARTY OF THE TRANSACTION.  Derivatives are so complex that the CEO’S of most companies participating in these financial instruments do not have a clue to the risks involved.  They are simply assured by a subordinate that they are "covered".  What happens if the losing party goes bankrupt?  You may want to do an internet search on "Long-Term Capital Management".  MBIA (who in the world is this?) recently disclosed its exposure to the CDO derivatives.   The impact to their stock was historic.  As an investor, how would you like to lose 70% of your investment in 90 days?

See http://www.bloomberg.com/apps/news?pid=20601087&sid=aHPogLA7dWPs&refer=home

Of course the average investor is the last to know about the company’s exposure.  The product of this company was "insurance" of a bet made by another company.  It looks like these companies ought to move their corporate headquarters to Las Vegas.

How did all this sub-prime mortgage crisis begin?  Some financial industry guru initiated adjustable rate mortgages (ARM’S) so that the home buyer could buy a bigger house than his balance sheet and income statement could afford.  This in itself defies the lending principles taught by the Dunn & Bradstreet Credit Course taught to all loan officers in the 1970’s.  (While in banking, I took the course.)  From the onset of making this type of loan, every lender in essence committed fraud as defined by the definition above.  The regulators looked the other way.  The CEO’S looked the other way.  The Ratings agencies looked the other way.  Alan Greenspan and the Federal Reserve promoted ARM’S.  The consumer was the neophyte in the transaction yet he will be the one to lose in the end.  The experts assured him that the loan was solid and it was justified.

Expect to hear the word "FRAUD" more often in upcoming financial news reporting.  The lawyers are going to make a lot of money in the world of "high finance".  We are at the beginning of this bubble popping event.  Litigation will keep the Federal Courts busy.  MBIA’S disclosure caused the ratings agencies to downgrade the securities they guarantee from "investment grade" to "junk status".  Since pension funds can only invest in investment grade instruments, they will be forced to liquidate their holdings in the affected securities.  This will cause a spiraling decline in value of the investments.  Someone is going to lose a lot of money.  "1929" is now being mentioned in the press with regard to this global financial event.

See: http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/12/23/cccrisis123.xml&CMP=ILC-mostviewedbox

An article in the Telegraph (U.K.) this weekend discusses the need to reduce the capital reserve requirements of banks (see http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/12/15/cnbanking115.xml).  The reserve requirements of a bank dictate or govern the amount of money banks can loan.  It is a "buffer" or reserve of cash to guard against bad loans.  For example, if the reserve requirement of a bank is 10% and the bank has a capital structure of $100 million, then the bank can loan up to $1 billion.  If you reduce the reserve requirement to 5%, then the bank can loan up to $2 billion.  With one change to a bank regulation, the bank could double its lending capacity.

Another regulation impacts the concentration of loans.  In the past, a bank could not loan more than 10% of its capital structure to any one customer.  In the above example, the maximum loan amount to one customer would be $10 million.  These regulations promoted safety to protect the bank’s capital which is its capacity to "keep the doors open".

Capital reserve requirements were put in place to protect the bank against itself.  The regulators found that a bank could weather economic cycle downturns if it did not overextend itself.  These requirements regulate the leverage capability of the bank.  If a bank suffered a loan loss, it was a direct reduction in the capital structure.  In the above example, if the bank had to write off a $10 million loan thus reducing its capital structure to $90 million, the resulting lending capability would $900 million (at a 10% reserve).  Reduced lending ability of banks causes a contraction in the economy.  With less lending capacity in the banking system, businesses and individuals cannot borrow money to finance expansion.  If the contraction is severe, existing notes of borrowers are "called".  In the fine print of loan documents, the bank generally can change the due date to "today" or change the due date by some formula.

On the other side of the bank’s balance sheet, they can restrict the cash outflow.  In their contract with you, the bank may restrict withdrawals or bank transfers. The also can delay withdrawals for a period of time.  If a bank gets into trouble due to its lending or investing practices, the depositors can be adversely affected.  The law (banking regulations) was designed to protect the banking system.  The depositors only have easy access to their funds if everything is operating normally.  However if the bank (or banks) made poor investing/lending decisions, the depositors are the last to know and will be limited to their deposit withdrawals.

The derivatives crisis is not over, I believe it is still in its early stages.  The fallout will be global.  "Reliquifying"  the banking system will be hyperinflationary.  Letting banks fail would cause a severe economic downturn.  This is ugly.  The central banks are attempting to inject huge amounts of cash into the banking system which ultimately is inflationary.  The unregulated derivatives market produced investments that banks participated in.  Those investments are moving from "investment grade" to "junk" status.  A bad investment is no different than a bad loan when considering its impact on the capital structure of the bank.

Protect yourself!  You’ve been warned.

Many people who read this site have financial assets whether they be bank deposits, stocks, or bonds.  In recent years, the financial industry has promoted the use of electronic deposits of stocks, bonds, and other instruments.  I am no longer confident that this method is safe from disruption.  I recommend that you take action now.  I recommend that you take possession of your stock/bond certificates.  If you have funds exceeding the FDIC limit within one bank, I also recommend that you distribute those funds among several banks to minimize possible exposure and disruption.  Keep some cash available, 1 to 2 months’ expenses if possible.

Recently, The Comptroller of the Currency in the U.S. approved the Basel II Capital Rule which specifically details capital requirement calculations of risk-based assets.  This "Rule" establishes the criteria for valuing risk-based assets that formerly had no regulation.  Without regulation, the financial institutions had no incentive to re-value a "junk" asset to market value. By keeping the original cost of the asset on the books rather than reducing the asset’s value based on market demand, the institution reports inflated asset valuations and correspondingly misrepresents their capital structure.  If you suffer a loss on the asset side, there is a corresponding reduction to the entity’s capital.  With less capital, the entity may not qualify to transact certain business that is reserved for the highest financially rated companies.

Ratings Agencies have been neglectful in analyzing those companies they classify.  Moody’s and other ratings agencies are the "watchdogs" of the financial arena.  Pension funds rely on ratings to determine what instruments they can invest in.  For instance, if Citibank issues "Commercial Paper" and has an investment rating of Aaa, a pension fund may be free to invest in the instrument.  However, if Citibank’s "Commercial Paper" grade is lowered to Ba1, Ba2, Ba3, etc. then the pension fund must divest itself of the investment.  A lowering of a company’s rating can have a dramatic, negative impact on its ability to borrow.  Also, if an institution has "off balance sheet" liabilities that would have an immediate and negative impact on its capital structure,  a pension fund could be investing in a "time bomb" and thus wipe out million’s of people’s retirement funds.  Enron was guilty of this type of scenario.  The ratings agencies were not oblivious of these "off balance sheet" investments.

What is Basel II?  (from Wikipedia) Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of Basel II is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Advocates of Basel II believe that such an international standard can help protect the international financial system from the types of problems that might arise should a major bank or a series of banks collapse. In practice, Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability.

If you read the Basel II Capital Rule, you may fall asleep.  Once awakened from your slumber you will realize that the financial world has become so complicated that the average person has no chance of understanding the financial condition (strength or weakness) of their bank.  Anytime you encounter complexity in financial transactions, watch out!  In an earlier posting I covered the topic of "real money".  Complexities increase as the liability of the instrument increases.

What will be the impact of the Base II Accord?  Ultimately it will force the financial industry to come clean with the over-valued securities contained within their balance sheets (or sitting outside their balance sheets, possibly as a footnote).  The capital structure of a bank dictates the amount of money it can lend.  If the capital of the bank is reduced by bad investments, the bank will have to contract its loans.  Existing loans may be called or not renewed.  This ultimately causes a contraction in the economic system.  "Fractional Banking Reserves" allows a bank to leverage its balance sheet.  On a positive note, additional deposits in the bank allow for a multiplying effect for lending capacity.  For instance, an additional $1,000 in customer deposits would allow the bank to create $5-10,000 in loans.  The capital of the bank is also considered in the loan expansion.  Removal of deposits and/or capital will cause a contraction in loans (and the ability to loan).

Why is all of this important to you?  If the banking system becomes weak, your deposited assets are at risk.  If an Internet stockbrokerage firm files bankruptcy, you could wait up to two years to receive your certificates (depending on the judge).  When there are prevailing winds of instability in the financial system, it is better to be safe than sorry.  Our risk level of financial meltdown is "orange".

On a recent flight I sat next to a gentleman from Venezuela. We spoke about the economic conditions within the country. The people are restricted in their ability to purchase goods outside the country. The current political system has strongly endorsed the use of credit cards by its people. Why? They are using the infrastructure of the credit card companies to track the purchases of the people. They require transactional reporting from the credit card companies. More and more, businesses are requiring credit card use over cash. If you can control the monetary system of people, you will gain control of their activities. This is another aspect of fiat currency creation. Since fiat currencies are not tied to gold, their medium can be coins, paper, or digital, virtual valuations. Digital currency eliminates a lot of headaches for those in control. That is the ultimate control mechanism. By moving all currency to a digital environment, you can easily monitor all activities of the population.

In the 1970’s, I was involved in setting up a “clearinghouse” association among banks. The intent of the clearinghouse was to eliminate paper and to establish a transaction standard to be used by the banks of the association. Our intent was noble. It was all about efficiency and cost savings. This coincidentally happened just after the U.S. went off the Gold Standard. As you can see, this evolution of “digital” money did not just start recently.

Digital money has fundamental flaws associated with it. The Western view of financial institutions is that the people administering the financial systems are sufficiently regulated to insure stability without loss to the customer. These financial systems are only as good as the weakest link. Fraud and theft occur continuously in the system. Most instances are not publicized. One of my credit cards was recently canceled and replaced sine there was a major theft of credit card information of one of the retailers’ computer files. The proliferation of digital use of money causes an exponential exposure to financial loss.

A visionary could easily chart a course for control of the population. There are certain steps those in power must take to assure their continued position over the people. There is no need to control the people if your focus is to serve the people. We are called to be “fruit” inspectors. If we see policies established to control currency, ultimately this will result in controlling the population. Many reasons will be given to justify the policy. In the end, those with the power over the currency will force servitude on the population.

1 Timothy 6:10 “For the love of money is the root of all evil: which while some coveted after, they have erred from the faith, and pierced themselves through with many sorrows.”

In a recent trip abroad, I once again saw the continued decline of customer service. Doesn’t customer service mean “to serve the customer”? Unfortunately, customer service is interwoven with short term profitability, not long term sustainable growth and profitability. In the U.S., Southwest Airlines grew to the most profitable airline in the industry. It was all about the customer. People look for a reasonable service at a reasonable price… with a smile. Why do we look for the smile? The smile is an outward indication of joy. Joy is an indication that you are walking in your calling. This is a subtle truth. At Southwest, everyone was happy while at other airlines, half of the people worked with “scowls” on their faces. Yes, people complained that they were “herded” onto the plane like cattle since there were no seat assignments. That did not keep Southwest from becoming a major competitor in the U.S. markets. Their focus on customer service and treating the customer with respect and appreciation caused travelers to overlook the “no frills” aspect of their business plan.

What happened to customer service? The love of money. Losses in the industry enabled the airlines to cut customer service as an excuse for their inability to make a profit. It the 20 year plan, is selling that free snack going to matter? “No” for two reasons. First of all the airlines do not focus on a 20 year plan, it’s all about the next quarter’s profit. Secondly, by lowering your customer service you expose yourself to reduced future income. Continued absence of customer service will send your customers to your competition. That is precisely why Southwest was able to flourish.

What is the solution? You should hire people who have a passion for customer service to represent you to the public. Obviously the revelation of Love must come forth to provide an adequate supply of people to choose from. Is the person applying for the position because the love people, or just the salary? If you want to sustain your revenue stream, match the job with the person’s calling. A customer service person could become one of your most valuable assets.

Southwest Airlines is losing the revelation that brought them to prominence. “Without a vision, the people perish.” Herb (the founding Southwest CEO) is out of the picture. His successors are losing the vision. Ultimately they will lose customers to the next airline who can sustain the passion for “serving”. Serving mankind produces sustaining wealth.