The Obama Administration (Democratic) and the Democratically held House and Senate are spending trillions of dollars in bailouts (GM, Chrysler, AIG, etc.), bank capital injections, “stimulus” spending, “Cash for Clunkers”, on and on and on and on.  In addition, the new administration is trying to spend another Trillion + with their plans for nationalized healthcare and the soon to be announced “Cash for Baby Diapers” and “Cash for Kittens” program.

To finance the everyday Trillions in normal spending plus the new Trillions in “stimulus” spending, the government can do one or more of the following activities to procure the money to finance its plethora of spending projects:

• increase taxes, which is politically risky;
• increase the debt on our children, which is also, as of late, becoming increasingly risky politically;
• the Federal Reserve can purchase the Treasury debt using its money printing ability called “quantitative easing”.

Although tax increases are being proposed they have not yet taken affect, instead the Treasury is borrowing more money and issuing more debt for our grandchildren to repay.  The Treasury (our grandchildren) now owes around $12 Trillion dollars and our primary creditors, Asia and the Middle East, are getting anxious about our ability to pay back this Mount Everest of debt. With our lenders becoming scared and anxious, the Federal Reserve System (the nation’s central bank) comes to the rescue by purchasing the Treasury Notes and Bonds.  Unfortunately the Federal Reserve System does not have any money to purchase anything, much less the Treasury debt, so it is just printing the money.  Or, more accurately, the Federal Reserve, by the blip of a computer key, creates an electronic credit to the Treasury’s checking account at the Federal Reserve.  Presto!!!!  Almost by magic the Treasury has the money to finance its various activities to run the government, fight the wars, and stimulate the economy.

The spineless politicians know that raising taxes is unpopular with current taxpayers and taking on more debt is becoming problematic as our creditors are getting uneasy about the creditworthiness of our young children and our unborn grandchildren.  Let’s not even discuss the selfish arrogance involved with forcing mountains of debt on the backs of our children and grandchildren. Don’t even get me started about that piece of financing chicanery.  Instead, our political giants in Washington have chosen a course which includes increasing the national debt AND printing money.   Printing money always looks like the easy way to finance a deficit, at the beginning, because you avoid all those pissed off taxpayers who don’t want to pay higher taxes in order to finance the increased government spending.  Printing money is the cheaters way of financing a debt.  This “solution” to financing the gargantuan levels of government spending always appears harmless in the beginning, but eventually the laws of supply and demand rear their inevitable head.  If you increase the supply of money flowing through an economy without increasing the supply of goods and services, the inevitable result will be higher prices. As prices begin to rise the reverse side of that coin is the value of the money begins to drop, which causes lenders to raise interest rates because they are concerned that the dollar they loan out today will not be worth a dollar in the future when the loan is repaid.  Economic endeavors take on too much uncertainty when the value of the money you receive in return for the endeavor becomes unreliable.  Money (the Dollar) is the “blood” circulating through the “body” of our economy and the entire world economy vis-à-vis the fact that the U.S. Dollar is the world’s reserve currency.  Imagine draining ½ the blood out of your body then replacing the missing blood with plain old tap water?  I’m not a physician, but I have to guess that your body would not work real well.  As a matter of fact, I would dare to guess that you would probably be very, very sick or very, very dead!  Likewise debasing our currency (diluting our economic blood) by printing money with the blip of a computer key through the Federal Reserve’s “quantitative easing” program pretty much accomplishes the same thing – it either makes the economy very sick or very dead!  Here’s why:  If you are a deposit customer of a bank (checking, money market, or certificate of deposit) you are, in effect, a money lender to that bank – if you have a deposit account at a bank you are lending that bank your money.  Likewise, the bank that turns around and lends your deposit out to a borrower of the bank is also a lender.  A bank “borrows” your deposit monies from you and then lends these monies out to their borrowers.  OK, now that we’re all aware that each of us to a lesser or greater degree are “lenders”, imagine what happens when the value of the dollar is declining by say, 10% per year.  If you lent the Bank your money you would need to get at least a 10% interest rate on your money just to breakeven.  Of course you would also want another 3 – 5% for profit.  In this scenario, the interest rate you receive on your deposit would need to be at least 13% – 15% (10% currency depreciation + 3% to 5% for profit).  Now what would you do if the Dollar was depreciating so fast that no one could really determine what the rate of decline was?  Would you “lend” (deposit) to the Bank at 13% – 15% if there was a good chance that the Dollar was depreciating at a rate faster than 10%?  Probably not!  During inflationary periods (depreciating currency equals rising prices), savers, who lend (deposit) to banks, or banks who lend to borrowers get hammered unless they are able to charge higher and higher rates of interest to compensate themselves for the loss in the value of the currency between the date they lend the money and the date the money is paid back.  During inflationary periods lenders either charge exorbitant rates of interest or they just quit lending.  If the inflation gets bad enough lenders stop lending altogether and begin trying to get rid of their currency as fast as they get it by purchasing hard assets (gold, silver, commodities, etc.) that will hold their purchasing value.  At the peak of an inflationary cycle, it’s possible that the rush to get rid of the currency and purchase something “hard” begins to look a lot like the children’s game of “Hot Potato”.  So you have a situation where savers (depositors) quit saving (depositing) and your banks get gun shy and charge exorbitant rates of interest to compensate and protect themselves from the currency debasement risk.  That’s Great!  In this scenario we have an economy that’s trying to function with no savings (no capital means no “Capitalism”) and/or sky high interest rates.  It doesn’t take a genius – our Washington leaders excepted of course – to understand that printing money to finance the Treasury debt is not a real prudent idea.

So much for theory!  Back to today’s reality.  What is going on today? 

With all the government bailouts, stimulus plans, “Cash for Clunkers”, etc.  that you’re reading about, what is happening is we’re financing these spending projects with more and more Treasury Debt, purchased by foreigners AND by the Federal Reserve’s money printing.  Our “funded” U.S. Treasury debt is approximately $12 Trillion and annual deficits (annual increases to that debt) are projected at $1 – $2 Trillion per year from now until the cows come home.  As noted above, this debt is being financed in large part by our Asian and Middle Eastern trading partners.  Soon, taxes will start rising, as well.  But the key thing to remember is that the government, which has been broke long before this crisis, has just taken on even more debt and the Federal Reserve is printing even more money.  Eventually, the world will wake up to the fact that the U.S. government and the U.S consumer are not particularly safe places to lend money.  This is especially true now that Big Government liberals control the Presidency and the two houses of Congress.  Our creditors (the Asians, Middle Eastearners) will either completely quit lending to the U.S., or they will demand much higher interest rates to compensate them for the high risk of loss through debt defaults and the inevitable debasement in the purchasing power of the dollar.   The reader should remember that anyone who invests in dollar denominated assets has two ways to make or lose money:

1. the actual rate of return on the investment itself;
2. the conversion of their dollar profits/losses back into the currency of origin.

If a foreigner makes a killing on a particular dollar denominated investment –  Treasury debt, corporate stocks, bonds, real estate, whatever – but then loses money when he converts his dollar profits back into the original foreign currency he STILL LOSES MONEY!  Foreigners DO NOT invest in this country because they love us; they invest here because they like making money in a stable economic, political, and monetary environment.  Right now the economic and monetary environments are extremely unstable.  Will the foreigners continue to show up to purchase U.S. assets, including Treasury debt, real estate, stocks, bonds, etc.??  What happens if they decide to go elsewhere to make their investments?  When the foreigners quit demanding Dollars to lend to the U.S. Treasury or to make other investments in Dollar denominated assets the Dollar will collapse in value and hard assets like gold, silver and other commodities will begin a parabolic rise in value.  Interest rates will begin to explode upwards as the world’s biggest debtor, the U.S. Treasury, gobbles up any available capital at any price.  The world’s second biggest debtor, the U.S. consumer, will be left to compete in the marketplace with Uncle Sam for any lendable capital.  Interest rates will head dramatically upwards.

There is an alternative to the above scenario.  The spineless politicians could actually have a “come to Jesus” moment  and decide to finance their spending in a more honest fashion than printing money or making our children and grandchildren pay for our selfish profligacy.  They could decide to tax the hell out of a dwindling base of taxpayers.  The problem with this, however, is that the people and companies that they will target for increased taxes (the undeserving “rich” and the dastardly and evil corporations) do not have to put their money to work in the U.S.  They can easily move offshore, or they can simply retire and quit paying taxes altogether.  Remember, the massive Baby Boomer generation is beginning to retire (i.e. quit working and QUIT PAYING TAXES) by the millions, starting this year, 2009.  Driving our most productive and profitable people and companies offshore has been going on now for 30+ years, but it will get worse as the government, run by Big Government liberals, will be much more predatory in its search for tax revenues.  As more and more of America’s productive capacity is driven offshore or retires, our tax base gets further and further eroded, which means the government will be more and more desperate to find money wherever it can.  The predatory tax policies of the government, the regulatory overkill, the extortionist demands of the unions and the trial lawyers have each contributed to the gradual atrophy of our manufacturing capacity by about 70% over the last 30 years.  This problem will only get worse.  Far worse!  Can you spell “France” or “Argentina”?

Don’t be fooled into thinking that the good times will return anytime soon.  The anti-capitalist/pro socialist sentiments of our political leaders will continue the inexorable decline of the U.S. economy and the average American is not savvy enough to understand that big government is not his friend.  The small government/low taxes/modest use of debt/personal responsibility philosophy of our founding fathers has long since been replaced by selfish “free lunchism” and a philosophy of “somebody else should be forced to feed me, clothe me, and take care of all my needs”.  As of the 2008 elections, the three branches of our government are now dominated by Big Government liberals who are committed to pandering to this attitude.  The average American and his Socialist panderers in Washington don’t understand that wealth is not created by government.  You don’t create more wealth by punishing the wealth producers through policies of income re-distribution.  We are rapidly becoming France, and the American public is not savvy enough to resist the allure of the “free” lunch provided by government and the allure of Big Brother solving all of our problems for us.  While we’re becoming France, Asia and India and the emerging 3^rd world countries will gladly accept and welcome the flight of capital from the U.S.  I’m afraid that the wheels have fallen off the U.S. racecar!  Don’t make any bets that the wheels are going to get put back on by the following policies being implemented and/or discussed by the genius Boobs in Washington:

• Give every American a check for $600.  Of course we don’t have $600 for every American, so let’s just borrow the money from our grandkids — OH WAIT !!! We already did that back in June and July of 2008.  I’m impressed with how much good that $160 Billion in extra debt has done to turn around our economy.  Genius!  Pure genius!
• If borrowing $160 Billion from our unborn grandchildren and sending it to low income Americans to spend on an Asian made TV set was such a great idea back in the summer of 2008, why not do more of it!  Of course the Asian made TV set cost $1,500 — he/she used their $600 government rescue check and then borrowed $900 from the same Asian that sold them the TV set.  Worked like a charm to stabilize our economy, didn’t it?  Genius!  Pure genius!
• Several billion for “Cash for Clunkers” was another doozy of an idea.  Of course the idea was to re-distribute $4,500 of taxpayer monies and give it to the “free” lunch crowd toward the purchase of an automobile, hopefully a Ford, GM or Chrysler, so as to payback the unions dominating that industry for all their support in getting the Democratic party elected.  Didn’t quite work out that way, most of the “Cash for Clunkers” went to purchase foreign made autos – Toyotas, Hondas, etc.  So we took monies belonging to our taxpayers (the people that earned the money) let it briefly pass through the hands of “free lunch” Americans where it eventually ended up in the hands of our Asian friends.  The good times don’t stop there, however, as the $4,500 was only a down payment and the car buyer had to incur additional debt on top of the gargantuan mountain of debt they already have. Genius, pure genius! 
• Another idea of pure genius floating around Washington is the idea of forcing banks and mortgage companies that hold mortgages to write-off and reduce the principal amount owed and reduce the interest rate charged to Borrowers.  I’m sure the banking and mortgage industry will see this as a great idea!!  If this is done, the mortgage industry will raise its credit standards and its pricing to compensate for the losses being forced on them by our geniuses in Congress.  On top of that, what are the chances that our under-capitalized banking system will be able to attract investor capital when the banks are being forced to write off billions in underwater loans because the idiot trial lawyers running Washington thinks it’s a good idea?  When the clowns in Washington have destroyed the ability of the banking system to recapitalize itself in the marketplace, I’m sure we can look forward to another doozy of a taxpayer financed bail-out plan for the banks.  Genius! Pure genius!
• Another whopper of an idea is to nationalize our healthcare system for everyone in the U.S., not just old people.  Since Medicaid and Medicare (“free” healthcare for the elderly) will eventually bankrupt the U.S., why not accelerate the entire bankruptcy process by offering “free” healthcare to 100% of American citizens, and, of course we wouldn’t want to exclude our illegal Mexican friends.  Genius! Pure genius!
• Let’s also help out our union organizers, who have done so much to bring health and vitality to our automotive and airline industries.  Let’s help them force their extortionist demands on even more American companies and turn every state into Michigan by making the secret ballot illegal when it comes to voting whether, or not, you want to have a union represent you in your workplace.  Legislation is ready to be signed by our new Socialist president that will make the secret ballot illegal.  So the union thugs can strong arm a recalcitrant worker who has to publicly declare his/her desire to not join a union.  Imagine the strong arming that will be done to the hold-outs that don’t want to unionize.  Genius! Pure genius!
• Here’s another great idea:  change the way Bank’s account for their assets.  Much talk is under way with the Boobs in Washington to eliminate the “mark to market” method of accounting.  “Mark to market” accounting means that if a Bank purchases a security  for $1 Million and its value declines to $400,000, then the $400,000 figure is what the Bank is allowed to show as its value.  To eliminate “mark to market” accounting means the Bank gets to continue the fairy tale that its asset is still worth $1 Million.  So Congress wants the Banks to utilize an accounting system that massively overstates the financial strength of a given Bank.  Sounds like a great idea!  Let’s see now, Banks are afraid to lend to each other now when we have honest accounting, let’s see what happens when the accounting begins to look like Enron and you can’t rely on the Bank’s accounting to accurately represent the financial strength of the Bank.  This is what the Japanese did in the 1990’s and they had a 15 year recession — it’s called the Lost Decade in Japan.  Genius!  Pure genius!
• The Socialists in Washington have given hundreds of Billions to bail out General Motors, and Chrysler (among others) in order to pander to the union voters in Michigan, so that they can keep their $72 per hour jobs and benefits packages, while their next highest paid competitor receives an average $45 per hour in pay and benefits.  Let me make sure I’ve gotten this correctly:  the Democrats in Washington are giving  the over paid union workers hundreds of billions borrowed from our grandchildren so they can continue to get overpaid 60% more than Toyota pays?  Genius!  Pure Genius!
• These same Socialists will come a running when the states run out of money and come to Washington for a bail-out.  California has already stepped to the front of the line with its multi-Billion dollar bail-out request.  Downsizing their spending never crosses the mind of these giants of the legislative process.  Genius!  Pure Genius!

I hope through my sarcasm in this article that you, the reader, get even a small inkling of the level of respect I have for those clowns in Washington and in many state capitols.  Of course, this is what you get when you elect trial lawyer hacks and con men and give them authority over the $14 Trillion American economy. What do you expect?

Folks, I’m painting a pretty bleak picture.  It’s not hard to see where we’re headed and I see nothing in the philosophical make up of Congress, our new President, nor the American people that would indicate that we are going to do an about face, cast off big government, and return to our founding principals.  If anything, it will get worse.  As the economy grinds into recession/depression the people will scream for more “free” government handouts.  The Socialists in Congress will be only too happy to pander to the people with more “free” government programs.  Can you say “Parley vous Francais”???

Now, assuming you think I am even ½ way right, what do you do about it? 

Suggestions for your wealth portfolios:

• Get out of debt as best you can.
• Sell any real estate that you don’t live in.  In general, real estate will not be a place to park your wealth.  Even the so called “bargains” that we’re seeing now will not look like “bargains” once interest rates begin their inevitable rise.  Remember that most real estate is purchased with credit, and credit, to the degree that it is even available in the future, will be very, very expensive.  High interest rates will kill the real estate market in most places.  There will be some markets that continue to reflect rising real estate values, but not overall.  Be careful if you think your market is immune from high interest rates or the recession contagion that is sweeping our country.
• If you must remain in debt, lock in fixed interest rates on the debt. Don’t get caught with a variable rate mortgage or home equity line of credit.  Interest rates are about to explode upward!  Go to your lender and ask them to “fix” the rate.  Interest rates are still at near historic lows.  This won’t last much longer.
• Sell your bond portfolio or avoid bonds altogether if you have monies to invest.  Higher interest rates will cremate the value of a bond portfolio.
• Be very, very wary of corporate stocks!  I know what all the Wall Street talking heads are telling you — stay in the market, or else you’ll miss out on all the money to be made when all of this turns around.  I’ve got news for the talking heads  – by the time this turns around you might be a lot older and  .  .  . a lot poorer!!!  I know you’ve probably lost a ton of money already, but you’re just going to lose even more if you don’t get out ASAP.  The market may continue to rally due to all the trillions in “stimulus”, but you must remember that this stimulus spending can’t go on much longer because our creditors will not tolerate it.  Eventually the music will stop, the money will stop flowing, and the rallies in the stock market will have to rely on its underlying fundamentals, which are abysmal.  The stock market may continue to rally in nominal terms, but will never be able to keep up with the inflation that is coming down the road.  For that you will need to be invested in precious metals and other commodities.
• Some stocks will do great, but you have to be very, very selective.  For example, I’m bullish on oil and gas stocks, over the long run.  War related defense type stocks will probably perform well.  I’m not seeing a lot of brotherly love appearing on the horizon.  If anything, warfare over oil and gas, fresh water, food stocks, commodities, etc. will probably be picking up steam in the near, mid and far future. And, thanks to our ever lovable terrorist friends, I think it’s a safe bet to assume that jihad and revolution will continue to pick up steam.  Despite the ability of our new Socialist president to walk on water I don’t think he will be able to persuade our enemies that they’ve been naughty and should give up their aims to destroy us.  Of course even if being “tough” was in the vocabulary of the new administration, considering the fact that the U.S. is bankrupt –we now can’t afford to be “tough”.  The U.S. is almost bankrupt – we can’t afford anymore wars and our enemies know this.  So even though the U.S. can’t afford anymore wars, the rest of the world will be only too happy to push their nefarious agendas and to start and fight wars. 
• Be careful about too much money being placed in “safe” bets like bank CD’s, money market accounts, etc.  The FDIC now guarantees most deposits and the U.S. Government guarantees the FDIC, so bank deposits will be “safe” in the sense that even if your bank fails, you will get the nominal value of your money back, because the government will just print the money to support the FDIC and your local bank.  But you will lose the inflation adjusted value of your money caused by the money printing. In other words, if the entire banking system collapses, and the FDIC collapses, the Federal Reserve will just print the money to reimburse depositors, and recapitalize the FDIC and the Banks.  Presto!  Everything’s great again!   Eventually the money printing will cause massive inflation (depreciating the Dollar).  Remember you’re not trying to keep your money, what you’re trying to keep is the purchasing power of your money.  There’s a huge difference.  For example, if your bank is paying you 4% interest per year and inflation is 10% per year, then at the end of the first year you have slipped 6% in your purchasing power.  Over a long period of time you will have lost all of the purchasing power of your money.  Historically, CD’s do not keep up with inflation.  The U.S. government is the largest debtor in the world, next in line is the U.S. citizen.  Governments and people that are deep in debt LOVE inflation because it reduces the real, inflation adjusted cost of the debt AND because it typically increases the value of any underlying asset associated with the debt.  In other words, the debtor pays back the debt with money that has been debased, so the lender gets the nominal value of his money back, but not the actual, real inflation adjusted value of his money.  Trust me that the interest rate you will receive on your CD’s will in no way compensate you for the real rate of inflation (currency debasement).  Inflation is about to explode!  Big time!  Can you spell “Weimar Republic” (post World War I Germany) or Argentina, or more recently Zimbabwe?  Hopefully, it won’t get that bad in the U.S., but who knows?
• Buy Gold and Silver and Platinum. 

It’s my opinion, of course, but I’m far more convinced that bad things are about to happen to the U.S. economy than I am that economic sanity is about to implant itself in the thick skulls dominating Washington.  I mean it’s very simple to me:  if the imminent collapse of the world’s entire financial system can only be saved by the U.S. government borrowing and printing trillions of dollars that we can’t afford, then we’re in a world of hurt.   Here’s the reality:  we have a government that is so deep in “funded” debt totaling approximately $12 Trillion that it can never be repaid, and that’s not even beginning to try to figure out how to pay back the unfunded liabilities estimated at $56 Trillion to support Medicare and Social Security for our now retiring Baby Boomers and existing seniors.  We have everlasting projected annual deficits or increases to that debt between $1 and $2 Trillion dollars as far as the eye can see.  Worst of all, we have a vast amount of the citizenry in this country that is now addicted to their government provided “free lunch” and will fight to the death via the ballot box to make sure that Big Government Spenders keep getting re-elected.  So, there’s no stopping the money spending freight train.  We have citizens in this country that are just buried to their eyeballs in debt and we have an economy that is 70% dependent upon that same consumer continuing to SPEND, SPEND, SPEND.  We have our Asian and Middle Eastern creditors who are beginning to worry about financing this mountain of debt.  They’re also desperate to get out from the pending collapse of the Dollar, but can’t figure out how to hit the “Exit Door” without getting stampeded themselves. The recent bull market in commodities is an indication to me that the Asians, in particular, are roving the planet in an effort to dump their dollars by purchasing and obtaining access to raw materials to support their own internal economies.  Their main concern now is how to dump the Dollar without anybody else figuring out they’re trying to dump the Dollar.  They don’t want to trigger the stampede out of the Dollar because with all their trillions of Dollar reserves they’ll end up getting crushed.  We have brewing right now a recipe for a Titanic type episode for the Dollar and for tsunami sized increases in interest rates, money printing, and financial and economic turmoil and a very real possibly of a monetary meltdown.  What more do I need to say:  Do you own Gold, Silver, and Platinum?

Add Gold and Precious Metals to your investing portfolio

• Too much consumer DEBT – rampant “consumerism” financed with DEBT.
• A massive trade deficit (more imports than exports) every year wherein the U.S. economy consumes far more than it produces.  If we were purchasing or investing in industrial capacity which could be used to produce more exportable products that would be OK, but instead we’re purchasing consumption products that don’t add anything to our investment base or our production capability.  Instead of buying factories and industrial capacity (investing) we’re buying consumption goods (TV sets and autos)  This would be bad enough, but to make things even worse we’re purchasing these consumer products with massive amounts of DEBT! 
• Too much government spending, financed by DEBT – the inability of our spineless political leaders to say “No” to government bailouts and programs to “help” every Tom, Dick and Harry.
• Financial institutions using too much DEBT (leverage) and not enough equity capital in their internal financial structures.

The reader will notice that too much DEBT and the trade deficit are the primary underlying causes of the problem, but the straw that almost broke the camels back in September 2008 is the sub-prime mortgage meltdown. 

In the olden days when people bought a home they went to a Bank or a mortgage lender and, assuming they had a good credit history, they could get a home loan for 80 – 90% of the purchase price.  The Borrower would have to:

• Have a good credit history;
• show adequate income to support the monthly mortgage payment;
• put a 10% to 20% down payment into the purchase of the house

A bank or mortgage company would then sell these mortgage instruments to the huge Wall Street investment banks (only 2 of the original 5 still exist) or to the two Government Sponsored Enterprises (GSE’s) with funny acronyms like, “Freddie Mac” and Fannie Mae” [“Fannie Mae” actually is the acronym for Federal National Mortgage Association.].  Let’s call these entities that purchase mortgages “Securitizers”. These mortgages (debt that is collateralized by a lien or security interest in a residential home) were accumulated and packaged into batches of mortgages and then “securitized” into multi-million dollar securities collateralized by the underlying mortgages and the homes these represented.  For example, “Fannie Mae” or “Freddie Mac” would batch together the mortgages from thousands of different Borrowers into a financial instrument called an MBS or “Mortgage Backed Security”, which is nothing more than a piece of paper that says, in simplified terms, “I OWE YOU Twenty Million Dollars at 6% Interest and I will pay this back in monthly payments”.  This IOU is backed or collateralized by the underlying home mortgages that pay back monthly payments.  Basically, they are bonds collateralized by home mortgages, which are collateralized by homes.  The “Securitizers” would then sell these MBS’s to the Asians, Russians, Middle East oil shieks, etc. 

The home owner would then mail in his monthly payments to the “Securitizer” who would then batch all the monthly payments from all of the other home owners and mail the monies to the purchaser of the MBS — a Middle Eastern Sovereign Wealth Fund, a Saudi Arabian oil sheik, or the Chinese central bank, etc.,etc.

Everything worked just fine .  .  .  for awhile.  The mortgage originator, the Bank or mortgage company would make a home loan, then sell the mortgage loan to a “Securitizer” for cash.  Once the Bank sold the mortgage and received its cash back it could then go out and make NEW mortgages with the cash it obtained from selling their earlier mortgages.  This “system” helped the mortgage industry by providing a ready source of cash to make new mortgages.  So there was always plenty of money to finance a thriving housing industry.  In fact, there was so much money chasing the available real estate that it created a “bubble” in housing and real estate prices.  The main way this happened was that it provided lots of cash to finance mortgages, which kept the interest rates down on the mortgages.  Remember in the old days,  the Banks could not sell the mortgages that they had originated so they would be forced to just sit on them and wait for them to pay off.  The Banks would eventually run out of cash and the resulting liquidity shortfall would cause interest rates to rise which would choke off the demand for mortgage money. This would, in turn, choke off residential construction, which would create less need for carpenters, plumbers, carpet manufacturing, etc., etc.   Wages would drop, economic activity would drop.  If you can’t afford a mortgage payment because the interest rate is too high because there is a limited supply of lendable mortgage money there will be less demand for new homes.  In other words the supply of mortgage money would have been limited which would result in the price of that limited quantity of money to rise.  The “price” of money is the interest rate.  High interest rates would have choked off the blossoming “bubble” in real estate prices — in hind sight that would have been a good thing.

So, in order to get around the problem of the Banks running out of money after making a few mortgage loans, the securitizing process was invented.  This way the Banks can sell their mortgages, get their money back, make new loans, sell the mortgages, get their money back, make new loans, sell the mortgages, get their money back, on and on and on and on.  The Banks charge enough fees in making a loan that it’s easy to see that if you can make 100 loans instead of just 50 loans, it will be way more profitable.  

The Asians and the Middle East oil sheiks were earning trillions of dollars by selling us manufactured goods (Asia, Japan, etc.) or oil (Middle East).  These recipients of our trillions of dollars did not want to stuff these dollars into their mattresses for safe keeping.  Instead they wanted to invest these monies in safe, interest bearing securities.  So, starting about 5 years ago the geniuses (I’m being facetious) on Wall Street noticed this huge supply of dollars that were being accumulated by our trading partners.  The foreigners were purchasing all the MBS’s we could sell them and were hungry for more.  They had more money than we had MBS’s.  So the Wall Street geniuses went to the mortgage industry and said “hey why don’t you guys start making more home loans”.  Well the only way you can make more home loans is to lower your credit standards.  Remember that for every 10 people that want a home financed by a home loan, only about 6 in 10 people can qualify (have good credit scores, good cash down payments, good paying jobs, etc.)  The remaining 4 out of 10 people get turned down and can’t buy a home.  Imagine how much more money the banks could make if they made loans to the 4 out of 10 people that DON’T qualify. The “Securitizers” told the banks and mortgage companies “hey don’t worry about the quality of the loans you make, we’ll sell the loans to the Asians and the oil sheiks and they’ll get stuck with the crappy loans”.  The banks and mortgage companies did not mind making crappy loans because they were going to sell the loans and by the time the loans went bad the Banks would have sold them to the “Securitizer” who would have then sold them to the Asians and Arabs. 

This all worked great  .  .  . for awhile!  Matter of fact it worked so great that the Wall Street geniuses began to buy hundreds of billions of dollars worth of these MBS’s and put them into their own portfolios.

So what’s the fuss all about?

1. Ok, you had a trillion dollars of loans made to people who didn’t qualify for an old fashioned mortgage loan – they had a bad credit history, low income, no down payment, etc.
2. You loaned these people virtually 100% of the money to purchase a house at the  peak in the prices of the real estate “bubble”.

This would have caused some pretty bad problems all by itself, but what caused the implosion is the way the Wall Street Banks arranged and structured their own internal financing.  Here’s where the problem caused the implosion:

A Wall Street Bank would purchase, let’s say, $100 Billion of MBS’s.  They got the $100 Billion from the following sources:  $97 Billion of borrowed money (debt) and $3 Billion of actual cash equity.  This is called using “leverage” because they took only $3 Billion of their own money and purchased $100 Billion of assets.  They did this by using $97 Billion of “leverage” or debt.  If the $100 Billion in assets goes up 3% in value ($3 Billion) they would make a 100% return on their money ($3 Billion of profit ÷ $3 Billion of cash equity = 100% profit on your investment).  You can see that this use of “leverage” can give you a great return if things go good, but it can kill you if things go bad.  A 3% loss ($3 Billion) would have completely wiped out the bank’s equity.  So, because of this tremendous use of “leverage” or debt, these Wall Street geniuses could either get rich or go broke.  Using this kind of “leverage” a Wall Street Bank can take a 3% profit on their portfolio of MBS’s and turn it into a 100% gain on their $3 Billion dollar cash investment.  Likewise, a 3% loss on their portfolio could result in a 100% loss of their cash equity.  The use of debt (leverage) was even worse with the Government Sponsored Enterprises (GSE).  They used 100 to 1 leverage ratios:  $101 in mortgage backed securities, financed by $100 of bonds and $1 of equity.  In this situation, a 1% loss in the value of a MBS would completely wipe out the equity of the GSE.  After that all the losses are born by the American taxpayer.  Not surprisingly this structure was concocted and sanctioned by the trial lawyer clowns we’ve elected to “serve” us in Washington.

Now you throw into this risky and volatile situation a recession caused by a consumer re-trenchment caused by an inability to spend anymore because of an inability to take on anymore debt.  The credit card, so to speak, got maxxed out!!  Remember the savings rate in America dropped below zero percent – we were consuming everything we earned and then some!  Remember the parable of the ant and the grasshopper?  The American consumer is the grasshopper on steroids!  Now comes the mortgage defaults and the collapse in house values.  In the above example a small 3% drop in the value of the MBS’s would wipe out the Wall Street Banks.  In the real world, mortgage defaults and falling real estate values caused 20%, 30%, 40% losses.  So, not only do the Wall Street Banks begin to fail because the debts they incurred to buy the MBS’s are going into default, their lenders are losing money left and right.  As these lenders lose money left and right, the value of their assets are going down to the point that their liabilities exceed their assets — they are now INSOLVENT too. It’s a never ending cycle of declining asset values, using too much debt, resulting in an ever widening circle of  INSOLVENCY, almost dominoe like when the trouble hits the fan.

Now, it’s important to understand that the Wall Street Banks are not really “banks”.  They are not chartered and registered and controlled like a regular bank is.  They were able to get away with a 30 to 1 leverage ratio (assets of $31, debt of $30, equity of $1), unlike an FDIC insured commercial bank.  Commercial Banks, like the one in your neighborhood, are only allowed to use a 10 to 1 leverage ratio, roughly speaking.  As long as a Bank’s assets don’t decline in value by more than 10%, only the stockholders will get wiped out, the lenders (depositors) will be fine.  But the current losses are so massive that even regular banks are seizing up.  A bank can only lend money to people based on that 10 : 1 leverage ratio.  If a Bank loses 10% of the value of its assets, which effectively wipes out the shareholder equity, then it can no longer lend money to its customers until it re-capitalizes itself with more money. 

Right now lots of banks have varying quantities of these MBS’s being held as an asset of the bank.  But because of the massive amounts of borrower defaults and declining real estate values nobody wants to purchase these securities from the Banks, so their market value has nose-dived.  No one wants this “toxic waste” and banks cannot sell it.  If you can’t sell it, then it has no value.  As the value of these investments falls, according to “mark to market” accounting rules, it wipes out the bank’s equity capital.  Remember for every $1 of equity capital a bank has, it can lend $10, but if your capital is reduced you have to reduce your lending.  If you have to reduce your lending then the business down the street who is trying to meet its 1^st of the month and 15^th of the month payroll won’t get the money and no one gets paid on pay day.  Likewise, car loans don’t get made.  Credit cards don’t get issued.  Debt for every purpose gets difficult to obtain, or it gets very expensive.  As this situation began roiling through our financial system and our economy, businesses found themselves unable to obtain financing.  Unable to obtain financing they began laying off employees.  Combining the above factor with the systemic problem of too many consumers with too much debt and you get the following:

• a decline in retail purchases, so retail outlets have less business therefore they need fewer employees;
• a slow down in home sales, so realtors, appraisers, home inspectors, etc.  have less business therefore they need fewer employees;
• a slow down in home sales results in a slow down in durable goods purchases (washing machines, appliances, A/C units, etc.) resulting in the need for fewer employees;
• a slow down in home construction resulting in massive layoffs in the construction trades;
• a slow down in mall, strip center, and commercial construction resulting in additional massive layoffs in the construction trades;
• a slow down in heavy equipment purchases resulting in the need for fewer employees;
• a slow down in manufacturing capacity resulting in the need for fewer employees

The slowing of the economy results in more job layoffs, resulting in more slow downs in economic activity, resulting in more job layoffs, resulting in even less economic activity — a vicious cycle!  This is where we are at the current moment.

 

With the stock market heading higher since the March 2009 lows, lots of people, including the talking heads on the business talk shows are bloviating about the end of the recession and the return of the glory days. Don’t be fooled! The economy is still chugging along, albeit with 9.5% unemployment, because of the trillions the government is spending. Now that the government is spending $200,000 for every $35,000 job we’ve saved, our grandchildren have another several Trillion of debt heaped on their backs, the taxpayers are revolting, and our creditors are beginning to think seriously about cutting off the money wasting spigot known as the U.S. government, what happens next? In the short term the money spigot will have a positive effect on the U.S economy and will be favorable to stocks, but what happens in a year or two when the massive government “stimulus” spending inevitably has to stop because our creditors will not tolerate it? The reader should recognize that borrowing money to keep up a lavish national lifestyle only works in the short run. Inevitably the money runs out and the lavish lifestyle has to adjust downward. This downward adjustment is what Washington is frantically trying to avoid with it’s trillions of spending “stimulus”. Imagine a politician trying to go in front of the voters and explain that his policies have destroyed America’s economic base and has heaped $12 Trillion Dollars of debt on the backs of our grandchildren. The politicians see no choice but to continue the borrowing and spending so that they can hide the real truth about the U.S. economy and their culpability in destroying it. Eventually, however, our creditors will force the downward adjustment on us by either cutting off the money spigot or by charging much higher interest rates on the monies they loan to us. When this happens the U.S. economy has to go back to the weak and crumbling economic foundation our leaders have bequeathed to us. We have to go back to a reality based on the fundamentals, rather than an illusion based on ever higher levels of debt. Like a family that has been forced to cut up their credit cards and now faces the true reality of having to spend less and consume less. A downward adjustment takes place — plain and simple. Reality sets in! It’s this “reality” that causes me to tell my readers to be very, very cautious when investing. What is this “reality” for the U.S.?

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Government Revenues and Expenses: You should recognize that the U.S. economy is in as good a shape right now as it will ever be in the future. We still have lots of highly productive, tax paying Baby Boomers that have not retired yet, so they will continue to work and pay taxes, and invest in the stock market. They are starting to retire now, but the big wave of retirement is still a few years off. So government revenues right now are still high and government expenses are still pretty low, at least compared to what will happen in the future. This reverses in a BIG way when they begin to retire: they pay less in taxes (less government revenue) and they receive more in government hand-outs such as Social Security and Medicare (higher government expenses). The first Boomers began retiring in 2009, so the process is underway for government tax revenue to shrink and expenses to explode upwards. It will get much worse in the future. Government revenues go down, government expenses go up!

Another attribute to a retired person versus a working age person is the fact that the retiree is beginning to liquidate his/her investment portfolio. So instead of adding to it they are subtracting from it. The multi-decade bull market in stocks is a by-product of this phenomenon. In their peak working and earning years the Boomers contributed trillions of Dollars to their pension plans by purchasing stocks and bonds. As they retire they will begin liquidating their portfolios in order to pay for living expenses. This liquidating of stock portfolios will act as a drag on the stock market; whereas in the past it acted like like a steroid on the stock market. The pressure on stocks will be downward.

Government Debt: Those of my readers who have wondered about the level of disrespect I have for our Washington leaders should ponder this: Our current and past leadership in Washington has created a situation wherein our children and unborn grandchildren are currently in debt to the tune of $12 Trillion Dollars . . . and they haven’t even been born yet! Imagine how much debt they can accumulate on their own when they’re actually born. The $12 Trillion debt was incurred by the Baby Boomer generation and the World War II generation, but there is absolutely zero probability that we will try to pay off this debt, or even make a dent in it, so we try not to discuss that little piece of bad information in polite company, especially around our Asian friends, who are 1st in line to receive the “your check is in the mail” phone call. If this wasn’t bad enough, the current policies that have been in place in Washington for decades now has promised another $40+ Trillion in additional debt so we can fulfill the cradle to grave “Nanny State” promises made to the Baby Boomers to pay for their retirement and healthcare costs. Our leaders have promised us the benefits, but just haven’t bothered to budget for the costs. I think they call it the “Tooth Fairy Plan”! Have we got great leadership, or what!

Realistic estimates of the government’s annual budget deficits for the foreseeable future estimate the deficits at $1+ Trillion per year from now on. Of course that’s part of the “Tooth Fairy Plan” mentioned previously, so who really knows what the numbers will actually be. More than likely they will be higher than estimated, they ALWAYS are!

Of course all of this would be a moot point if our creditors were brain dead or had a financial death wish because they would just blindly continue to finance whatever new debt the Bozos in Washington want to heap upon the mountain of previous debt. Unfortunately for us, our creditors, the Asians and Middle Easterners, are not stupid and they have already begun to publicly criticize the new administration for its massive spending programs and their concerns for the viability of the Dollar in the future. They have even voiced support for replacing the Dollar as the world’s reserve currency. When, not if, this happens there’s far less demand for the Dollar, therefore there’s far less demand for Dollar denominated assets – stock values decline, bonds go through the floor, real estate values decline.

Unionization of the workplace: The three branches of the government are now dominated by the liberal faction of the Democratic party, which has a political philosophy that panders to the unions. FACTOID: the unions are the single greatest contributor to the Democratic party; the trial lawyers are the second greatest contributor to the Democratic party. Legislation is being readied that will eliminate the secret ballot in elections to vote on whether you want a union to represent you in the workplace. After this legislation is passed you will have to endure the taunts and threats of the union thugs when you are forced to publicly declare that you are not in favor of the unionization of your workplace. The intimidation factor will assure that much of the workplace is unionized. To understand what unionization will bring to America on a national scale, just look at the automakers in Michigan, which are dominated by the autoworkers unions and to the airlines, which are dominated by unions. Both industries are on the verge of collapse and bankruptcy, in large part due to the extortionate demands of their respective unions. Imagine this on a national scale! After imagining that, then imagine the vast amount of production capacity and entrepreneurial talent that will migrate “offshore” to escape this “workers paradise”! As companies and entrepreneurial talent either retires or leaves the U.S. in order to escape the unionized workplace, the government’s revenues will decrease at the same time that laid off workers are filing unemployment claims. Government revenues go down, government expenses go up!

Global competition: At the end of World War II the U.S. had 5% of the world’s population but produced 75% of the world’s products. Obviously this could not go on forever and this situation has now reversed itself in the last 20 years. The U.S. now competes with billions of Asians and Indians who are happy to earn $2 Dollars per day in income with no benefits, compared to the unionized Detroit automakers who receive $72 per hour in income and benefits. With our very high wage structure, our oppressive regulatory environment, high income taxation, and other impediments such as corrupt and abusive trial lawyers and unionization of the workplace, Americans are finding themselves unable to compete in the global marketplace. America accumulated vast amounts of wealth since World War II, but we’ve spent and wasted it and now we must compete in a world that has little sympathy for the fact that we have the 2nd highest corporate tax rate in the world, a confiscatory personal income tax rate that exceeds 55% of a person’s income, a “free lunch” entitlement culture, a tort legal system that wastes hundreds of billions of dollars a year in frivolous lawsuits and needlessly higher insurance premiums, and a wage structure that is far higher than our primary competitors. While the clowns in Washington flounder around trying to figure out more ways to bankrupt us and pile more debt on the backs of our grandchildren, our global competitors are kicking our butts!

Carbon Based Energy: The price of carbon based fuels – oil, coal, natural gas – are all very low at the current moment. What happens when the Harvard Boys in Washington begin taxing carbon energy usage in order to accomplish their “green agenda”? The U.S. economy cannot withstand high energy prices, whether caused by political stupidity or by supply/demand factors. Nor can it withstand the upfront infrastructure costs to switch from carbon based fuels to renewables or even to switch to natural gas fuelled autos, trucks, and locomotives. The Bozos in Washington are just dying to do something stupid like impose carbon taxes, but what happens if energy prices just vault upwards on their own because of normal supply/demand factors? What happens to the stock market when much higher energy costs are factored in? It goes down, that’s what! When stocks go down, capital gains taxes go down as well. Government revenues go down!

National Infrastructure Spending: Our nation’s infrastructure has been slowly and inexorably deteriorating. It’s estimated to cost $10 – 20 Trillion to update and fix. Since there is NO Santa Clause: Government expenses go up!

Wars and Terrorist Attacks: There’s a lot on the horizon in world affairs that do not look promising. To wit: Russia’s belligerence with its trading partners and former satellite countries; North Korea’s psycho dictator, who is just itching to kick sand in the face of the U.S.; Iran’s and Pakistan’s psycho mullahs are also standing in line behind the North Koreans to kick sand in our faces. Since the U.S. is bankrupt, we probably can’t afford a very tough foreign policy. As a matter of fact we’re so broke we probably can’t even afford a wimpy foreign policy, but be that as it may, our worldwide footprint will require the U.S. to spend monies defending our people and our economic interests. Government expenses go up!

The American Consumer: The average American consumer is drowning in DEBT –home, auto, credit card, and school loans. A retrenchment or cutback in spending by the consumer would not be a big problem for an economy geared towards production and exports, but the U.S. economy is 70% based on consumption, not investment. As the overly indebted consumers begin to retrench and cutback their spending because of job losses or the fear of job losses, the economy staggers. Corporate revenues decline, so profits drop. Since the value of a corporate stock is nothing more than the anticipated value of the future earnings of the company, a decline in the profits will cause the value of the stock to drop. When individual stocks drop in value, the market itself (the Down Jones Average, the S & P 500, etc.) drops in value. Another way to look at this is to recognize that 70% of the U.S. economy depends on each and every one of us to SPEND, SPEND, SPEND!! So what happens when you’re so deep in debt and your job prospects are being jeopardized? You stop spending! Corporate revenues and profits drop so stock values drop in unison.

The U.S. is entering a multi-decade period of massive government deficits heaped on top of an already gargantuan level of government DEBT. The government will finance this debt with borrowed money, albeit at much higher interest rates, and the Federal Reserve will turn on the money printing presses, referred to as “quantitative easing”.

In the above narrative I’ve briefly described the systemic, foundational problems that confront the U.S. economy and its capital markets. It’s not a pretty picture. Betting that these systemic problems are going to yield a higher stock market in the long run is a long shot. It would be better to change your mindset and recognize the long term structural problems facing the country and to invest accordingly. Temporarily, however, the Main Street economy and the stock market will benefit from the trillions in spending “stimulus”, but since this spending cannot be sustained, the long term fundamentals will eventually rear its ugly head. One of the few investments that will perform well amidst the problems facing the U.S. is precious metals – Gold, Silver, and Platinum. As a matter of fact in my next article I will discuss the fact that Gold has risen every year for the last 8 years. Every year for 8 years! During this period Gold has risen more than 400%. No other investment that I know of has performed that well, that consistently! And the good news is that the Gold market is only 8 years into what will most likely be a bull market lasting 20 or 30 years. It’s just barely getting started. Got Gold?