Let Us Explain How the Financial Industry Worked

Readers unfamiliar with modern macro-monetary theory would probably like to stay that way. But that doesn’t stop us from limbering up in order to pitch the system at you.

Last November, Wachovia Bank of the Tar Heel State was worth more than $100 billion. Two weeks ago, it was worth $20 billion – after confessing a loss of more than $8 billion in the second quarter. Buy yo ho…last week it was back up to $37 billion.

What’s going on? Well, many people will tell you that the banks are coming back. Don’t believe it. The boom in finance is over, as the vast majority of our speakers at last week’s Agora Financial Investment Symposium pointed out. Two more banks failed over the weekend – First Heritage of California and First National of Nevada.

In his speech at the Symposium last Tuesday, The Rude Awakening’s Eric Fry quoted Charlie Munger, vice-chairman of Berkshire Hathaway:

“Include me out. A lot of rot has crept into the financial system…we’ve got plenty of scandals coming.”

Even the survivors will never recover to the glory-days levels they had a year or two ago. That doesn’t mean they won’t have some spectacular bounces. As they say on Wall Street, even dead cats bounce. But it will be a very long time before the big banks enjoy the kind of profits they made back in 2003-2007 – when they made billions by lending to people who couldn’t afford to pay it back.

Let us explain how the financial industry worked. A guy borrowed some money from some other guy who borrowed the money from some other guy who borrowed the money from the Fed at a lower rate than the going rate of consumer price inflation. Then, the lender booked a profit on the transaction and paid himself a bonus…while selling the loan on to someone else, whereupon both of them booked a profit and paid more bonuses. Then, the loan was packaged up with similarly infected credits, rated AAA by Moody’s, and then sold on again – and again, everyone involved in the transaction, including the cleaning lady, booked a profit and got a bonus.

“The leveraged stupidity of the last few years was perpetuated by the ratings agencies,” Eric explained to the 800+ attendees, “They wanted to quantify things that are unquantifiable. People did not really know what they were getting themselves into.”

In the four years leading up to the credit crunch Wall Street’s big banks paid themselves $250 billion in bonuses. It didn’t seem to matter to anyone that the source of the wealth was largely a swindle…and that real profits would never be realized. Now, the banks are writing off the bad loans…and turning to the taxpayer for a handout. But no one has offered to return a bonus, as far as we know.

Of course, this is just the genius of modern Anglo-Saxon capitalism – the most capitalist institutions pay out their capital in bonuses. Then, when they get in a jamb, they turn to the taxpayer for relief. Of course, the taxpayer spent all his money too. He’s lucky to be able to fill his gas tank – with a credit card! Which is why Hank Paulson is so eager to deceive the world. He knows that if the foreigners ever catch on to what a scam the United States is running, they’ll stop lending it money. And then, Wall Street, Washington, and the lumpenconsumer himself are all up the creek.

“The common thinking among Americans is comparable to wearing a string bikini on a polar ice fishing expedition,” quipped Eric, “look good until you perish.”

“It’s time to sell risk and buy caution.”

The average lumpenhouseholder is getting whacked coming and going. Inflation smacks him on one side…and a deflationary slump wallops him on the other.

Page 3 of the weekend Financial Times presented two headlines:

“EDF raises electricity prices 17%” said one.

“Economy now contracting, analysts say,” reported another.

How can a giant utilities company raise prices during a slump? Foreclosures are running at twice the rate of a year ago. And homeowners are finding it harder and harder to refinance. With mortgage rates rising and house prices falling, only 3% of homeowners qualify for refinancing, according to one estimate, as compared to 30% a year ago. House prices have fallen 10 months in a row. They’re down 18%, according to Case/Shiller. And they’re only about half the way to where they’re going. That’s Nouriel Roubini’s guess. He says that ultimately, credit-related losses will swell to between $1 and $2 trillion, and that a recession will last at least a year.

The big market news last week was the fall of the price of oil. It fell to $122 by Friday. Has the black goo topped out? Maybe. But as we explained, the bubble in oil is not like the bubble in tulip bulbs or dot.coms. Oil is probably the most essential commodity in the modern world. And as near as we can tell, the number of people who want it is going up, while the amount of it readily available for sale is going down. It might go up. It might go down. But it’s not going away. And when all is said and done, the real price for oil is likely to stay higher than it was before 2003. Which is why utilities are raising rates…and airlines are losing money. They were hoping oil prices would quickly abate. They haven’t. And they probably won’t go down too far – even if the peak has come and gone for this cycle.

The whole world bobs on a frothy sea of cash – which makes it hard to know what anything is really worth. The dollar rose a little last week – but at $1.56 to the euro, it is hardly what you’d call a “strong” currency.

Still, Treasury Secretary Hank Paulson says a strong buck is “very important” to the United States. The top man at Treasury understands how dependent the United States is on the kindness of strangers with familiar money in their pockets. There’s some $13 trillion outside the U.S., says Jim Rogers. And the Gulf States alone are adding to their pile of cash at the rate of $1 billion per day. If these foreigners ever decided to dump the dollar…there would be pandemonium in the currency markets. The dollar would collapse…and the United States would be unable to borrow the money it desperately needs in order to continue living beyond its means.

Bill Bonner
for Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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3 Comments on "Let Us Explain How the Financial Industry Worked"

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knowingisbeing known

What would it take for the gulf states or China to dump the dollar? I suspect their own desires on being the next empire? In this world it isn’t too crazy to consider, for what they would lose in making their own financial assets worthless, they would recover if the gamble paid off! God help us all if they were ever brazen enough to do it.

Man in a Shed

I sometimes wonder why the English speaking worlds left wing parties don’t make more of an issue of this ….

Unpopular Truth
Why don’t they do it? Simple. They’ll lose a lot of their own value. They have US dollars, which they’ve exchanged for a lot of their own time and services (even slave labor prices add up over time). If they suddenly cause this to drop by trying to sell all their USD and buy something else (like EURO or Yen or AUD) then all it will do is ruin their own value, and drive up the price of whatever they’re buying into. Currency is bought and sold in pairs. You can’t dump one without inflating the other. To get out… Read more »
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