Saturday, January 31, 2009

The Circle of Wealth

There are some big dollar numbers being moved around right now in the quest to save our banks. So what is really going on? Let's take a simple look at what just happened in our banking sector.

Over the past 8 years, America's investment banks made a lot of money loading up on toxic debt. The more debt they added to their balance sheet, the more fees they collected. This was not enough for them, however, so they created another market called the derivatives market. This market is unregulated and exists as a gambling type atmosphere where money was bet on how markets would move. The more money in this off balance sheet market, the more fees the investment banks collected.

Then everything fell apart. The losses on their balance sheets have been staggering and without government support every major financial institution in this country would currently be bankrupt. The derivatives market would have exploded, and we would be living in a world where money would be given to strong businesses or to people that could afford to pay it back. That scenario made no sense to our leaders, so let's look at what did take place.

Over the past four months these major investment banks have received hundreds of billions of dollars in bailout money from the Federal Reserve and the government. The intention of the bailouts has been to unfreeze the credit markets and get banks lending again.

Here's how the money was created: The treasury created money by selling treasury bonds and depositing that money at the Federal Reserve. (A treasury bond is a debt that our country must pay back in the future. A sacrifice that must be made down the road, with interest.)

The Fed then gave this money to the investment banks to help them handle the write downs taken on their toxic assets. What did the banks do with the money they were given?

They bought treasury bonds
!

Do you see the Circle of Wealth paid for by the American people?

The following chart shows the money borrowed/printed and given to the banks who have then hoarded the cash. (Click below)




So what is the result of this money shuffle? The treasury (the taxpayer) now has hundreds of billions in new debt, the Federal Reserve now has a balance sheet full of toxic debt, and the insolvent banks have enough cash to keep them alive for a few more weeks. (A similar formula is taking place with the auto companies, and soon to be taking place with California)

None of this cash helps the American public. They did not get any of the profits during the boom years, and they are now paying for the losses during the bust. The losses will be paid by increased taxes or through inflation. Both take money from the public.

Businesses understand what is happening right now, and the more intelligent ones are looking around wondering why they do business in America. Along with these businesses, many Americans are starting to look around and wonder why they are holding American dollars. This can be seen clearly in the surge of the price of gold and silver over the past month.

This trend will continue to gain momentum throughout the year as our leaders attempt to rape, pillage, and plunder the value of our currency. I think at some point during 2009 we will see the very first of the American public begin to enter the gold and silver market. This will mark the beginning of the optimism stage of this long term secular bull market, which will create the greatest transfer of wealth in human history.

While there will continue to be massive pullbacks along the way, the very wealthy around the world are taking their positions in the metals. They will wait for the public to come in as herd at the very end of the bull market as they have time and time again throughout history.

Tuesday, January 27, 2009

Here We Go

The news leaked this evening of the new plan for an "aggregate" bank, or what will be known as a bad bank.

This bank will be government run and will purchase toxic debt off the balance sheets of the remaining investment banks. This was the original intention of the TARP program that was scrapped due to an unforeseen glitch. Let me try to explain:

A bank has a mortgage on its balance sheet that they currently value at $100. The government would then come in and purchase that mortgage at what they would consider fair value. Let's say that they consider that mortgage worth $50 and purchase at that price. Sounds good right?

Here's the problem. There are currently no other buyers in this market other than the government. That means that the price they pay for the asset now determines the market value of that asset. Think of it like a house. If you have a similar house to your next door neighbor, and he sells his house for $200,000, that is now essentially the free market price for your home and what someone would use as a guide to offer you.

So, here's where you run into trouble. With the government's purchase of the mortgage at 50% of the value of what the bank had it worth, that means whatever mortgages the government does not purchase, the bank must now write down the value of that asset by 50%, bringing them down to free market value. This would have sparked trillions of dollars in write downs for the banks, which would have caused systemic risk. (Previously discussed)

This new bad bank has found the "solution" to this problem. They are going to replace the difference in the price they pay for the asset with the price the bank currently has it marked at by buying shares of common stock in the bank.

The government has then justified the purchase of these assets by saying they have the ability to hold them to maturity. This means they will never have to sell the assets. It will just sit on their books until the loans expire.

The second part of Tuesday's news was the Fed's new housing program. Discussed previously in great detail was the Fed's purchases of Fannie and Freddie mortgage debt to help clear their balance sheet and allow them to make new, horrible, loans to home buyers at very low interest rates. (Mortgage rates are currently between 4 and 4.5%)

As I mentioned before, there is still one problem with this program; the people who have already bought homes that cannot afford them. That solution was announced this evening:

The Homeownership Preservation Policy for Residential Mortgage Assets

This new program allows the Fed to start modifying the loans of current mortgages. The Fed will do this by reducing interest rates on the current mortgages, extending the term of the loans, or even accepting a reduction in the outstanding principle on the loan.

The cost of these programs will most likely end up in the multi-trillions. $3, $4, $5, $6 Trillion?

What force is out there to measure and account for all this inflation and debt?

Gold.

The world's last true accountant. It is watching every dollar enter the system, waiting to revalue itself as it has time and time again throughout history.