An Appetite for Risk

The world is awash in credit and debt. What I mean is, credit had been extended to anything with a shadow. Almost every Tom, Dick and Harry participated in it. From the central banks around the world to the man in the street, everyone has done exactly the same thing: finance whatever needs to be bought.

And when we ran out of money, no problem! There was more where that came from. In one sense we couldn’t spend money fast enough. As soon as it was gone, there was more suddenly available. So we just finance the house again, take out some equity (which always rises) and do one of two things – Pay off credit cards (so we can load more debt on them) or just spend the cash on things a home improvement (that is no longer reflected in the price of the home) or a vacation.

Remember how MasterCard taught us that those memories were priceless? Hope you got some good ones… because you “done bought something you can’t eat,” as one of my teachers used to say.

At a time when we are drowning in debt, we are also out of money.

When a debtor is out of money, he has no ability to repay. And when a creditor has borrowers who are out of money, the creditor has no income. No earnings. No power to make better loans.

So how are banks in America posting “profits”? How did Citigroup, Bank of America, AIG and Wells Fargo jump 400% in stock price? Are they worth 400% more? Are their earnings up 400%? And where in the world did all this money come from?

These companies were just bankrupt… yet found a way to get back above water. And not just above water – they are making moon-shots!

Their share price should be zero (or less, if possible!). How are they worth so much more now?

As I have written before, mark-to-market accounting rules were repealed in favor of a fictitious slight of hand. Banks no longer have to list their distressed assets at the fire sale price they should be worth. Instead they get to record their value as the price they bought them, or what they believe they will be worth in the future.

In other words, it’s like me refinancing my house, but doing my own appraisal and assigning it whatever value suits me. I want cash out? Just pad the value of the house. I can’t afford a higher payment? No worries, I just pad my reported income. Two years down the road I can’t afford my payments anymore? Easy, just follow the same refinancing procedure all over again.

But my family and I would only have one toxic asset to deal with. The banks have them coming out the wazoo!

They are still in possession of the faulty loans and derivatives that caused this entire mess in the first place. Nothing has changed – except the accounting!

The banks always counted on that. This time, however, they are the ones left holding the bag. What are they going to do with all this JUNK? How can they unload it without attracting suspicion? How can they clean up their books without the short sellers making a profit off their downfall? They can’t. It’s a Catch-22.

But the real problem is that the US banking system would come crashing down in a minute if this were known and understood by the general public. The banks know it. The Fed knows it. I suspect that there are some congress people who know it.

But here’s where the rubber meets the road. Government engineered a bailout. They wanted the banks to lend to Joe Consumer. But the banks didn’t. And frankly, Joe Consumer didn’t want it. He was too busy trying to figure out how he was going to repay all the money he had already borrowed against his house. Especially with the boss breathing down his neck, threatening job terminations if he wasn’t more productive than some cheap labor in India.

So the banks were sitting on a good deal of the money from the Fed in order to protect them from future losses. Some of them have even paid it back. But the truth is, from an accounting standpoint, they don’t need it anymore. From an accounting standpoint, their mortgages and derivatives are all valued at a big fat surplus. Why keep federal money? Why incur interest charges when “all is well”?

If they can show a profit from an accounting standpoint… and if they can repay their bailout money (plus interest)… and if they can still service the customer at the drive-in window or the teller counter, what’s the big deal? What am I crying about?

It’s all because those toxicities still exist. And they all have to be accounted for, whether the government says so or not.

We should have learned, or have been reminded of, one of the greatest lessons in the world from convicted felon Bernie Madoff: “Be sure your sin will find you out.”

Even the greatest engineered schemes on the planet come undone at some point. No Ponzi scheme can continue forever. But if you are very bright (as Madoff was), you can keep the game going for a long, long time.

But what if you’re not brilliant? After all, I doubt the government is as smart as Billionaire Bernie. Luckily, if that’s the right word, the government has another way to keep the game going, using one thing it has that Madoff didn’t.


Gobs and gobs of it.

The government’s massive wad of cash is what keeps the game going. And foreign investors lending us money. And millions of pensioners happy as long as they receive their check on the first of the month. And the multitudes of purchased votes that are blissfully sitting on the dole.

But it’s not just the United States. Every country in the world is in the same pickle – because every developed nation believed they could successfully manipulate the game. The problem now is that the governments are running out of money. The United States has been broke for a long time, of course, but it could still trade on the value of its good name… and it did. Other nations are not so lucky.

The United States still possesses the reserve currency status; other nations aren’t so lucky. We still boast the largest GDP; other nations are not so lucky. I’m pretty sure we still have higher tax receipts, and more room to raise taxes than other nations. But somehow, I can’t bring myself to call that lucky…

But as it is an “option,” I have to think that whatever smarts our government does have, someone will eventually realize it. Good Lord, deliver us.

I do not honestly think that anyone can seriously contest us in the role of reserve currency, no matter how many times China rattles the saber.

Twenty years ago, China couldn’t even feed its own people or keep them employed. Now it is boasting a 7% annual growth rate. Despite the massaging that may be done to the numbers before they are released, we can already see that a country growing solely on stimulus cannot grow very long. The weaknesses in China’s underbelly are already becoming apparent. She is an export economy. And people are not buying.

She cannot save the world, whatever her strength might be.

There is another round of destruction coming. The banks will have to come clean. If you thought the residential crunch was stunning, wait till you see what’s coming on the commercial front. It will be a tsunami of epic proportions. Banks are not lending now, and the chances of business expansion are lower than at any time in recent history. No one will be buying excess of anything except maybe food and precious metals, so businesses will not continue to post profits. Without profits you can’t service the loans you have, and rolling them over will be out of the question. The day is coming… don’t let it catch you by surprise.

But until that day arrives, we must deal with what we have.


Bill Jenkins
for The Daily Reckoning

The Daily Reckoning