Toxic assets from the shadow economy

Full story here. Even the Wall St. Journal has pointed out that funny money is coming from a black hole. Gasp–what was Rupert thinking? Must’ve been a rogue journalist, telling the truth like that.

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“The Obama administration has finally come up with a plan to deal with the real cause of the credit crunch: the infamous “toxic assets” on bank balance sheets that have scared off investors and borrowers, clogging credit markets around the world. But if Treasury Secretary Timothy Geithner hopes to prevent a repeat of this global economic crisis, his rescue plan must recognize that the real problem is not the bad loans, but the debasement of the paper they are printed on.

Today’s global crisis — a loss on paper of more than $50 trillion in stocks, real estate, commodities and operational earnings within 15 months — cannot be explained only by the default on a meager 7% of subprime mortgages (worth probably no more than $1 trillion) that triggered it. The real villain is the lack of trust in the paper on which they — and all other assets — are printed. If we don’t restore trust in paper, the next default — on credit cards or student loans — will trigger another collapse in paper and bring the world economy to its knees.

If you think about it, everything of value we own travels on property paper. At the beginning of the decade there was about $100 trillion worth of property paper representing tangible goods such as land, buildings, and patents world-wide, and some $170 trillion representing ownership over such semiliquid assets as mortgages, stocks and bonds. Since then, however, aggressive financiers have manufactured what the Bank for International Settlements estimates to be $1 quadrillion worth of new derivatives (mortgage-backed securities, collateralized debt obligations, and credit default swaps) that have flooded the market.

These derivatives are the root of the credit crunch. Why? Unlike all other property paper, derivatives are not required by law to be recorded, continually tracked and tied to the assets they represent. Nobody knows precisely how many there are, where they are, and who is finally accountable for them. Thus, there is widespread fear that potential borrowers and recipients of capital with too many nonperforming derivatives will be unable to repay their loans. As trust in property paper breaks down it sets off a chain reaction, paralyzing credit and investment, which shrinks transactions and leads to a catastrophic drop in employment and in the value of everyone’s property.

Ever since humans started trading, lending and investing beyond the confines of the family and the tribe, we have depended on legally authenticated written statements to get the facts about things of value. Over the past 200 years, that legal authority has matured into a global consensus on the procedures, standards and principles required to document facts in a way that everyone can easily understand and trust.

The result is a formidable property system with rules and recording mechanisms that fix on paper the facts that allow us to hold, transfer, transform and use everything we own, from stocks to screenplays. The only paper representing an asset that is not centrally recorded, standardized and easily tracked are derivatives…”

This is becoming akin to having someone buy real things like houses and food with monopoly money, and, when he’s even short on monopoly money, he can come take some of your present (and future) ‘real’ money (which is moving closer to monopoly money status daily) to make good on his bets. These CDSs are not insurance per se, since many, if not most, of these purchasers of CDSs didn’t own the underlying item being issued. But we couldn’t necessarily know that because the parties involved with these contracts don’t broadcast what they’re doing, prices, naming names, etc. But the counterparties come out of the woodwork when an insured item goes down. Would you feel safe living in a world where Ashley from Investment Banking (or perhaps Guido with no neck and hair on his thumbs) has bought 100 insurance policies against your house catching fire–and that he could use monopoly money to buy them? And when it burns down (there was never a question of if), not only will Ashley or Guido end up getting paid back–in real dollars– but the insurance company that did insure your house probably won’t have enough money to pay for the reconstruction costs. Now multiply this scenario by about 10 million and you end up with more money than there is on earth.

Of course, the real solution would be to no longer accept monopoly money or to pay for illegal or fraudulent insurances. This is not an ‘easy’ solution since those formerly boring and trustworthy insurance companies and banks were spending like a coked-up Vegas gambler, with avergage Joe’s annuity, whole life policy, other tangible insurances and mortgages all intertwined in this festering tumor. Which means there’s going to be a lot of blood spilled to cut this out, but it must be excised now. Otherwise we succumb to a world where a few own every single thing in the world and the rest of us become dispossessed slaves.

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