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Injin

Anatomy Of A Quadrillion Dollar Scam - Post-gluttony Era

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http://www.oftwominds.com/blogjune09/quadr...-scam06-09.html

Debts are never assets, yet debts have been defined as assets by banks, investment houses, credit card companies, and brokers. If these entities or persons loan you money, they call the resulting debt on your part an asset for them, because you will ostensibly pay them back the principal, with interest, creating profit for them. If you give them money, they must pay you interest (no matter how small), and hence they consider your money a liability. They offset that liability by loaning your money to others at higher interest and pocketing the difference. This used to be what banks did and how they made their money.

With the massive deregulation of financial markets, banks began to effectively merge with investment houses and insurance companies under a rubric of "complete financial services," leveraging and investing money in higher and higher interest ventures, with greater and greater risks, involving huge theoretical profits. These new ventures tended to involve something other than lending, i.e. providing "services" or "guarantees" in the form of default insurance and other promises.

None of these new ventures and products were or are necessary to the credit market, day-to-day business, or efficient economies. Some of these vehicles could, if managed correctly with adequate capital reserves, do some positive things like distribute risk. However, most appear to be simply a boondoggle-- siphoning real value, adding nothing, and substituting a promise of astronomical theoretical future riches for actual ability to pay out. Most have not been managed correctly and have neither had the necessary capital reserves nor prudent investment strategies to shore up those reserves. Predictably, the world financial market is now in free fall.

In this debacle, a profound metaphysical error has emerged--viewing debt itself as an asset. This has fateful and far-reaching practical consequences we are just now beginning to see and assess. Debt adds nothing. It does not produce anything or hold any value. Debt is not the asset but rather the lendee’s ability to pay that debt, interest and principal, and, failing that, provide something of real value (collateral) that covers the full amount of the debt. Those are the assets, which the debt-extender holds claim to through a legal contract.

.............

Oddly enough, given the fatal metaphysical error I have mentioned (debt = asset), almost all the concoctions stemming from that error have been "rationally consistent" with the irrational premise. Too bad logical consistency with false premises will virtually guarantee disastrous conclusions. Let us spell out in detail this "rational" behavior stemming from irrational assumptions.

First let us recast traditional debt in tune with the new, false assumptions mentioned above. In traditional economics, "good" debt would be a loan extended to someone with sterling credit, with a healthy income or revenue stream, and collateral that far exceeds the value of the loan. Collection is fairly simple. Risk is transparently low. The interest rate charged would be correspondingly relatively low. "Bad" debt would be someone with a low to middling credit rating, with borderline income or revenue, and with collateral that flirted with being equivalent to the loan. Risk is transparently higher. The interest rate charged would be correspondingly higher to offset the greater risk of default and failure to recoup the full value of the loan. "Insane" debt, would be someone with an incredibly low or no credit rating, whose income or revenue is well below what is necessary to pay off the loan, and whose collateral property has no, or even negative, equity in it (think of houses bought with liar loans, balloon loans, negative amortization loans).

In a traditional system, people with "insane credit" would never get a loan, because they have no way of paying it, and they do not have collateral worth anything near value of the loan. In the new system, debt is "equivalized" so that what I have called "insane" debtors actually become the most sought after market! Why? Think about it: No distinction is being made between debts that can be paid and those that cannot possibly be paid (at least without completely fantastical projections of increasing value in the property, commodity, stock, etc. upon which the loan is being drawn). All debt is seen as asset. Insane debt = bad debt = good debt = asset. This is confirmed empirically in Moody’s rating of absolute junk as secure AAA investment.

Continues at link...

Good stuff and it's disheartening to realise this error still hasn't been fixed.

Edited by Injin

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Second, unregulated financial instruments like credit default swaps had no effectively no reserve requirement at all, because their reserve "money" was also based on "assets" based on "marked to model" theoretical value. Furthermore, this unregulated, self-assigned value could be, if they so desired, leveraged into investments in ratios that could defy infinity. As we know, zero multiplied by a million is still zero. Imagine if you or I could assign a 200 billion dollar asset value to our dog’s house, and use this assigned value to buy a major international conglomerate.

When people say that this is "unthinkable," what they are really saying is, "I don’t want to think about it. I don’t want to acknowledge this happened or can happen." However, just connect the dots. It’s simple. Is there anything preventing this from happening. No. Applicable regulations have been removed, and those still on the books have not been enforced. Is there any reason not to do it given the incentives and principles at play? No. Therefore, it will happen.

What we have is essentially private, unregulated money creation prompting hyperinflation in certain markets. We have an intensely large, and at this time, unknown amount of counterfeit money and value mixed in with the real. Apparently we cannot tell real money apart from counterfeit money very easily, and/or we are trying to hide the counterfeit cash through deficit bailouts from the taxpayers.

We also know that we cannot keep these fraudulence-based markets (i.e. housing) artificially inflated because they are so out of line with reality-based fundamentals and facts. However, we also largely do not have the grit to face the consequences of this rip off.

This is goooood......

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What we have is essentially private, unregulated money creation prompting hyperinflation in certain markets. We have an intensely large, and at this time, unknown amount of counterfeit money and value mixed in with the real. Apparently we cannot tell real money apart from counterfeit money very easily, and/or we are trying to hide the counterfeit cash through deficit bailouts from the taxpayers.

Yes. We have already had the inflation. Bad money has crowded out good. What we have now is the determination of Government to ensure that those holding the bad money* are compensated by those that hold the good money**.

It's all a little like handing out free smack outside a school. Once all the kids are junkies, the police come along and force the teachers to pay the dealers for the kid's drugs.

*debt assets

**labour

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I need to stop reading this stuff, it makes me want to put bricks through windows in Canary Wharf.

Or maybe I need to go fetch the bricks.

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Until we change the accounting imbalance of unlimited assets against limited liability it will never be fixed.

I'm not too sure what you mean by this, to be honest.

Can you flesh it out a bit?

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When discussing the anatomy of the situation where almost the entire population has been put in debt, and apportioning the blame for the situation you always have to keep in mind "who benefits?". The bankers get the blame at the moment, but their actuall gain is really pretty low in relation to the capital allocated to the loan once you take into account inflation, tax and risk of default. I reckon that who really should be blamed is the government, since 1) They set up the situation, and 2) They benefit the most by a long way.

To clarify when someone gets a loan they have to pay back somewhat more than the value of the loan at some point in the future, the amount paid back over the value of the loan, when inflation is taken into account will usually be somewhere in the range of 1-10%.

The anatomy of the loan repayal situation:

  1. To pay the loan they need money.
  2. To get the money they need to work, when someone works they pay taxes because that's just what happens at the moment.
  3. The owner of the business they work for allocates a certain sum to paying the employee.
  4. From that money is first deducted employers national insurance, a misnomer since it comes out of the employees money.
  5. Then employees national insurance and income tax is deducted.
  6. Any profits from the loan that the bank gets it has to pay tax on.

This means that from what the employer paid out to the employee my sums indicate that 39% at basic rate and 53% at higher rate go to the government. So if you borrow £100000 over 25 years using very approximate maths you might have to pay back about £200000 of capital and interest payments, the bank gets £100000 and the government gets £127000 from income related taxes on loan repayments, and about 30000 of the banks profits as corporation tax as well. There are other ways it gets money too like VAT on any repears, and miscellaneous ways like for example insurance that has to be bought because the house is so expensive, they have to pay insurance premium tax and the insurance company has to pay tax on its profits.

So you can see that the biggest beneficiary of debts by far is the government. It is actually quite difficult to quantify how much the gain of the government is because so much of the system revolves around the government and what it takes, the situation is really quite bonkers.

Fast forward to the moment the problem is that there is so much parasitic debt because they got too greedy, if you were to liken the situation to a dog with ticks (feeding off the dog by sucking its blood), if the dog has a few ticks its health is unaffected, if it has a lot of ticks the dog will get sick and listless but the ticks will be fine, if the dog is covered with ticks then the dogs health will be so compromised it will die and so will the ticks.

Edited by Della

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Until we change the accounting imbalance of unlimited assets against limited liability it will never be fixed.

To my mind CDS's were always the problem (not CDO's in the main). If you slice and dice CDO's to "good" and "not so good" pieces then even though the value could deterioate you would still have "some" value, albeit less. No different to a corporate bond. CDS's, on the other hand, have no intrinsic value as they are multiple bets on the same underlying security. In fact, as has been shown, lots of money has been made on this very bet-that the underlying security falied and multiple insurance holders (CDS holders) then collected. To think that there was no "insider trading" between individuals on both sides of the trade at different institutions would be naive in the extreme. If this piece of the puzzle doesn't surface shortly I will be gobsmacked.

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A debtors willingness and ability to repay their debt obviously has some theoretical value to a person expecting to receive that repayment.

In the old days taking security was one way to ensure that the debtor was serious about repaying the debt.

the other way to ensure a person repaid was to ensure that loans were only given to people who had the kind of character that meant they were likely to repay the debt.

Seems to me to be idiotic to say that a debtors liabilities are not a financial asset of some meaningful amount or probability

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A debtors willingness and ability to repay their debt obviously has some theoretical value to a person expecting to receive that repayment. In the old days taking security was one way to ensure that the debtor was serious about repaying the debt. the other way to ensure a person repaid was to ensure that loans were only given to people who had the kind of character that meant they were likely to repay the debt. Seems to me to be idiotic to say that a debtors liabilities are not a financial asset of some meaningful amount or probability

I think the point* was that debts based on loans to people of dubious character who cannot afford to repay and where the security is worth less than the debt, are not assets. Not that debt cannot ever be an asset.

*In the linked peice, I'm not commenting on Injin's views. :)

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I think the point* was that debts based on loans to people of dubious character who cannot afford to repay and where the security is worth less than the debt, are not assets. Not that debt cannot ever be an asset.

If you are owed 100 and have security of 80 the loan asset that is defaulting that is tied to the security of 80 has value of 80.

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I'm not too sure what you mean by this, to be honest.

Can you flesh it out a bit?

The concept of limited liability of companies provides the platform for people to take high risk policy decisions.

Consequently, the potential reward is much higher then the potential loss.

When we emerge from this crisis we should take the radical step of reforming the limited liability of all companies.

It's been abused for decades.

Just don't ask me how !

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If you are owed 100 and have security of 80 the loan asset that is defaulting that is tied to the security of 80 has value of 80.

It can't have, because unlike the asset, there is recovery risk. You gotta go to court, prove the debt, keep records etc etc

Promises must always be inferior to the actual.

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CDS's, on the other hand, have no intrinsic value as they are multiple bets on the same underlying security. In fact, as has been shown, lots of money has been made on this very bet-that the underlying security falied and multiple insurance holders (CDS holders) then collected. To think that there was no "insider trading" between individuals on both sides of the trade at different institutions would be naive in the extreme. If this piece of the puzzle doesn't surface shortly I will be gobsmacked.

I would disagree. First, CDS can be a great risk mgmt tool. Second, there are two counterparties to every single CDS contract:what one makes, the other loses. Thus, no money is being cooked, net.

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I would disagree. First, CDS can be a great risk mgmt tool. Second, there are two counterparties to every single CDS contract:what one makes, the other loses. Thus, no money is being cooked, net.

Apart from the frictional losses, fees and so on of course.

Oh, and they might not have ever had the money in the first place.

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