Bankruptcy for Lehman

Okay, things are coming together in the Lehman situation, though there are worries about things coming apart more generally as financial markets continue to unravel. Let's start with John Jansen:

Bankruptcy, by John Jansen: The New York Times is reporting(via Deal Book) that Lehman will file for bankruptcy this evening.

The story notes that the Federal Reserve will take lower quality assets as collateral for loans and a consortium of banks will provide financing to assist an orderly liquidation of the company.

I am not sure that one can have an orderly liquidation of a company which has been around for a century and a half. This is confirmation, proof positive that we live in a most troubled time. One week ago we watched and cheered (I did) as the Treasury rescued FNMA and Freddie Mac.

That effort provided only the briefest interlude of calm in the markets. There is some historic climax to this series of crisis lurking just around the corner. At every twist and turn in this year long saga the result which has ensued has always been the worst case scenario. We are , I believe, headed for a very very ugly end to this story.

Government has not been able to hold bank the forces which have taken down financial giant after financial giant. Capitalism demands pain. Good risk is rewarded and imprudent risk is punished. We were engaged in an orgy of imprudent risk taking for nearly a decade and now a heavy price will be paid for the violation of so many simple and common sense precepts of trading.

I truly fear for our economy and our system the next several days.

He has thirty years of experience on Wall Street. That last sentence has my attention.

I'll add more as I find it. [Update: much more on the continuation page]

Naked Capitalism:

NY Times: Lehman Filing For Bankruptcy: ...update from the New York Times' Dealbook:

Lehman will seek to place its parent company, Lehman Brothers Holdings, into bankruptcy protection, while its subsidiaries will remain solvent while the firm liquidates its holdings, these people said. A consortium of banks will provide a financial backstop to help provide an orderly winding down of the 158-year-old investment bank. And the Federal Reserve has agreed to accept lower-quality assets in return for loans from the government.

But Lehman’s filing is unlikely to resemble those of other companies that seek bankruptcy protection. Because of the harsher treatment that federal bankruptcy law applies to financial-services firm, Lehman cannot hope to reorganize and survive as a going concern. It will instead liquidate its holdings.

It was not clear whether the government would appoint a trustee to supervise Lehman’s liquidation, or how big the financial backstop would be.

Lehman’s broker-deal subsidiaries would not be a part of the bankruptcy filing...bankruptcy lawyers say that customers are likely to receive their holdings back.

Moreover, changes to the bankruptcy code mean that counterparties to Lehman’s credit-default swaps can seize their collateral at any time, posing an enormous potential risk to the entire financial markets. Investment banks, hedge funds and other financial players labored throughout Sunday to offset their exposure to Lehman, moving their contracts to other firms.

Note we predicted that the authorities would lower collateral standards as a finesse for Lehman. This is a back-door bailout. Dow futures opened down 300 and S&P futures down 37, which would seem subdued ex the stealth provision of central bank support.

Update 6:55 PM Reader Jim Bianco e-mailed this observation on the futures trading:

It’s all about Merrill. They need to announce a deal with BAC before the open. If they do not, they plunge to $10 to $12 (from $17) on tomorrow’s open and no way does BAC pay $25 to $30. Then Merrill is at risk of blowing up and a crash becomes very possible.

More on Merrill and AIG: Merrill Said to Discuss Merger With Bank of America. Bloomberg. Also, Rush Is On to Prevent A.I.G. From Failing - NYT.]

Felix Salmon:

Lehman: All Fuld's Fault, by Felix Salmon: John Gapper has the first best Lehman post-mortem:

Fuld never changed, not really. He was still the same dark, obstinate Lehman loyalist that he had always been - a man who never wanted his firm to be sold. And, in the end, Mr Fuld's pride and obstinacy stood in the way of Lehman's desperate efforts in the past half year to right itself...
He had devoted so much of his life and his personality into moulding the bank he could not accept its decline. If he had sold out earlier, Lehman might have survived but he was too proud. It was hubris, followed by nemesis.

Gapper's right: the fate of 24,000 Lehman employees lies on Fuld's broad shoulders. This credit crunch is a category-4 hurricane, and Fuld is the idiot who decided to hold his ground rather than evacuating and living to fight another day. Now his 158-year-old house has been destroyed. It's sad, yes -- but it's also tragic.

Willem Buiter is optimistic that allowing Lehman to fail won't cause a chain reaction in financial markets:

What if Lehman files for bankruptcy and nothing much happens?, Willem Buiter: It now looks likely that, unless the US Treasury blinks and makes public resources available to support a private take-over of Lehman brothers, the investment bank will have to file for bankruptcy.

The argument for putting public money into the rescue/take-over by JP Morgan Chase of Bear Stearns was that Bear Stearns was ‘too interconnected to fail’. ...

Lehman Brothers is larger than Bear Stearns, so what’s different now?

One obvious difference is that since the demise of Bear Stearns in March, the Fed has created the Primary Dealer Credit Facility and the Term Securities Lending Facility. .... With these market support facilities in place, the threat of a fire-sale of illiquid assets is less daunting. ...

The second obvious difference is that since Bear Stearns crashed, the US Treasury has, through its de-facto nationalisation of Freddie and Fannie, taken an additional $1.7 trillion of debt on its balance sheet, as well as a $3.7 trillion exposure to mortgage- and MBS-guarantees, with a fair value of around $350 bn. ...

If the US Treasury, either directly or indirectly ... were to offer financial support for a rescue of Lehman or for any other investment bank (or commercial bank, for that matter), the floodgates could open and the fiscal-financial position of the US Federal government could be materially affected. Japan not that long ago shared a sovereign credit rating with Botswana. A trillion here, a trillion there and the US Federal debt could lose its triple-A rating.

Another explanation is that the argument in support of the Bear Stearns bail out is wrong, or at any rate is no longer considered true in the US Treasury. ... Or at any rate, no stronger argument than for the tax payer to support US automobile manufacturers, steel manufacturers or manufacturers of garden gnomes threatened with bankruptcy.

We may have a test as early as tomorrow morning ... of whether there are significant systemic externalities from the failure of a household-name investment bank. I am optimistic that investment banks will turn out to be more like normal businesses than like the negative-externalities-on-steroids painted by the Fed and the Treasury during the Bear Stearns rescue. The frantic attempts by the Fed and the Treasury to broker a private sector rescue/takeover of Lehman suggest that the monetary and fiscal authorities are not too confident that a household-name investment bank can fail without causing significant systemic damage. If that is indeed the case, one wonders why, six months after Bear Stearns went belly-up, there still is no special resolution regime (SRR) for investment banks, along the lines of the SRR for commercial banks administered by the FIDC and the SRR for Fannie and Freddie administered by the Federal Housing Finance Agency (FHFA, the regulator of the GSEs). The Treasury and the US Congress have much to answer for.

Arnold Kling:

Bryan Takes Over the Treasury, Econlog: My guess is that the government is not getting out of the bailout business. You have a session in which the folks being asked to take over Lehman say, "Give us X, Y, and Z, or we walk." The government negotiators think that's too generous. They let the folks walk. My guess is that the folks will come back to the table. Or someone else will come to the table. ... I predict that lots of folks pull all-nighters, and there will be more dramatic developments before the markets open tomorrow.

Paul Krugman:

When is not a bailout a bailout, by Paul Krugman: So the word seems to be that Lehman will be liquidated — hey, no more taxpayer takeover of risk, no more moral hazard; but to cushion the markets against the shock, the Fed will start accepting lower-quality assets, such as equities, as collateral for its credit lines — hence, more taxpayer takeover of risk, and more moral hazard. Oh, kay. By the way, I’m not sure this was the wrong thing to do. But it drives home the essential craziness of the situation.

Tyler Cowen:

I don't mean to overwhelm you with posts, but...: It's hard not to report this:

$$$ On CNBC they are saying that AIG has asked the Federal Reserve for some kind of emergency bridge loans. Can the Fed lend to an insurance company?

$$$ Federal Reserve is dramatically expanding its emergency lending program. It's now going to take all sorts of collateral, including equity.

$$$ "Take a very deep breath. It looks almost certain that this week will be the one where we see the financial implosion in U.S. banking and brokerage that many have been expecting for some time," Paul Kedrosky says.

$$$ With Merrill Lynch, Lehman Brothers and Bear Stearns gone, everyone is asking whether Morgan Stanley and Goldman Sachs will survive as independent investment banks.

The Fed's Press Release is here. There are comments from Angry Bear, and Naked Capitalism has Bank of America Buys Merrill For $29 a Share and AIG Asks Fed for Help. Also, Felix Salmon has one more, When Can We Start Breathing Again.

Brad DeLong, commenting on Krugman's statement (see above):

Lehman Bros. Goes Under, But the Fed Assumes the Role of Patient Capital. Brad DeLong: It seems to me that this is the right thing to do--as long as the Fed can borrow from the Treasury, that is, so that it can conduct its own operations on a properly-large scale. The Fed's portfolio is large. It is not infinite.

A few more from Paul Kedrosky: Why Would BofA Buy Merrill?, Curious Capitalist: The Day Wall Street Stood Still, and Felix Salmon: Lehman: The Media Meltdown.

I just realized I hadn't offered any of my own thoughts. Without the kind of detailed data available to regulators, it's hard to fully assess how likely this is to spread and create a larger, out of control, downward spiral.  But the first goal should be precisely that, to prevent a bigger problem from erupting and sending the economy into a tailspin. On that basis I've had no problems with the interventions to date.

But at some point the federal authorities have to let banks stand or fall on their own, even the big ones, and that point comes as soon as the system can withstand the shock without collapsing. Is that time now? I don't know for sure, I don't think anyone does, and this isn't a "you're on your own" moment for banks generally in any case, there are backup systems in place and steps to ease pressures, e.g. accepting lower quality assets as collateral, and the Fed would certainly step in if things start to go downhill fast. But one thing I do know is this. I hope political pressure on the Fed and Treasury, the type of grandstanding we'll see on this issue from politicians beginning tomorrow morning,  does not force policymakers to take a hands off stance prematurely. The politics of intervention are bad, but the economics of a major crash are much worse. So a cautious hands off - as seems to be the case right now - is fine, but if a more active role is needed now or in the future, there should be no hesitation about moving in that direction.

Dean Baker makes a point about press coverage:

The NYT Turns to the Arsonist to Analyze the Fire: Greenspan on Bank Bailouts: Alan Greenspan is certainly in a position to know about the problems the financial system is facing. After all, there is no one who bears greater responsibility for today's events.

But, it would be appropriate to remind readers that Greenspan was the arsonist here. He was the one who choose to ignore the abusive lending practices in the mortgage industry that became widespread under his tenure. He was the one who chose to ignore the growth of an $8 trillion housing bubble.

When he said that, "This is a once-in-a-half-century, probably once-in-a-century type of event," it might have been worth pointing out that he was the arsonist who created the conditions for the extraordinary set of events hitting Wall Street.

Brad Setser:

The world is changing, fast: After Argentina was — after a long, drawn out process — denied financial support from the IMF and left with no choice other than default and devaluation, the US Treasury encouraged the IMF to provide a large backstop to both Brazil and Uruguay. That strikes me as the right metaphor for tonight. But rather than worrying about the rest of the world, the US authorities now are worried about the health of the United States’ own financial system.

Lehman failed, at least in part because the Treasury and Fed were not willing to put taxpayer money on the line to help Lehman.

Merrill accepted Bank of America’s offer. And one assumes — based on Yves Smith’s analysis - that the Fed was quite happy that Bank of America was willing to bid for Merrill.

AIG is on the ropes and needs cash, which could imply that the type of institutions with access to the Fed’s liquidity window keeps expanding.

The Fed certainly is going to accept a broad range of collateral to try to avert John Jansen’s worst fears.

Felix is hoping that the deal for Merrill — together with the expansion of the Fed’s liquidity facility — saves the day. He defines short-term success as a fall in the equity market of less than 5%:

If AIG hasn’t collapsed after New York markets open and the broader stock market is down less than 5%, all that will mean is that there hasn’t been a systemic meltdown yet. It’s going to take a long time to liquidate Lehman and unwind all of its positions, and nobody has a clue how that’s going to play out.

I personally would pay more attention to the credit markets than the equity market. Partially that is because I understand credit markets better than equity markets. But that is also where it would seem, at least to me, the real shock may lie. ...

The US banks need to rollover a lot of debt over the next few months. Debt was was issued two years ago, back when the market was driven by greed rather than fear, is now coming due. The bankruptcy of Lehman could be more of a surprise to the debt market than the equity market; after Bear, the risks of holding equity in a major US bank were pretty clear. Up until now, though, unsecured creditors of large financial institutions generally have been protected from losses.

Back when the New York Times Magazine profile of my former boss/ co-author of “Bail-ins and Bailouts” came out, I said, more or less, that I would think the current crisis was over when it was clear that Nouriel Roubini was too pessimistic. Right now, though, things are still playing out far too close to his script for comfort.

Andrew Leonard:

Wall Street's nightmare goes nuclear: ...It is not an understatement to call the current crisis one of the most devastating challenges modern capitalism has faced in living memory. ...

There will be much more to say about all these things as the week wends on. ... But as we wait for Monday's opening bell at the New York Stock Exchange, let us remind ourselves, once again, of the most important lesson that economists, investors, and voters should be taking from this carnage.

Over the last three decades Wall Street sought, and received, a climate of deregulation and minimal oversight that allowed it to create new markets at will, permitted investment banks and commercial banks to commingle their activities, and exempted critical new innovative financial products from any meaningful government restraint.

Now, we are staring at the kind of mess you get when you give two-year-olds a few buckets of paint and tell the baby-sitter to take the day off. Clean-up is going to be a bitch.

Real Time Economics: 

The Government Stood Firm. Was It the Right Call?: The decision not to inject government funds stayed firm into the weekend, despite the threat that firms would walk without taxpayer support. Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke felt strongly about the need to resist a bailout... They faced continuing worries about moral hazard along with overarching concerns about distorting markets ...

Fed officials remain acutely aware of the system’s risks. ... Now they face another decision: Whether to support AIG with a lending lifeline.

More: Brad DeLong: It is Not About *You*, Paul Kedrosky: Blame the Short-Sellers, William J. Polley: Monday is going to be a rough day in the markets, and hilzoy: Donald Luskin Reclaims His Title.

Credit Slips:

Lehman 2007 Bonuses?, by Adam Levitin: Lehman paid out around $5.7 billion in bonuses in 2007. Are those bonuses safe? Maybe not.

The bonuses might be recoverable as fraudulent transfers---transfers made while insolvent...

Thus, the key question is whether Lehman was solvent when it paid out the bonuses?... On an equity basis, almost assuredly yes, but on a balance sheet basis, that might be a closer call...

If Lehman was not solvent when it paid the bonuses, then I think there's a fraudulent transfer. ...

Of course, it takes a challenge by a creditor whose claim arose before the bonuses were paid, but ... it only takes one of them, owed a single cent, in order to challenge all the bonuses. The lack of a creditor might protect the bonuses, but as creditors look to carve up what's left of Lehman, the thought of recovering a decent chunk of $5.7 billion is going to look very appealing.

Comments

[anne]

"The story notes that the Federal Reserve will take lower quality assets as collateral for loans and a consortium of banks will provide financing to assist an orderly liquidation of the company."

No choice here.

[anne]

"It’s all about Merrill," AIG too?

[anon]

The BofA Merrill merger is on - tonight.

[dd]

Well, Geithner's Gettysburg address has come to pass. My bet hedge funds are taken out; regulated banking matches out their derivatives books, long term investors understand why derivatives are WMD and with a little luck the system is reboots. Where is paine when you need him?

[Winslow R.]

The shadow or 'nonbank' sector with its 50x leverage is dying.

The system is in flames and the fire is spreading rapidly. My 'favorite' recession indicator (C&I bank lending) just went slightly negative.

If long-term mortgage rates don't fall to 5% or less within the next 30 days I will join Roubini in his assessment that we are headed into a deep recession.

Rates are at about 5 5/8% right now. Time for Paulson to really start using that bazooka. He's off to a good start but until rates fall below 5 1/2% they have little effect.

[dd]

Paulson has the bazooka pointing the wrong way and has no interest in everyday homeowners. A judgment has been made that banking can be segregated from beleaguered joe sixpack debtors. This is a major misjudgment; but bankers are like that.

[Bruce Wilder]

"It's all about Merrill"

I would think it is all about Merrill, and AIG and WaMu and Goldman Sachs and Morgan Stanley and Citigroup. And, ultimately, about the bankruptcy of George W. Bush's and Sarah Palin's America.

[Winslow R.]

" A judgment has been made that banking can be segregated from beleaguered joe sixpack debtors. This is a major misjudgment; but bankers are like that. "

I see sentiment allowing homeowners that put 20-30% down being 'saved' and the nonbank sector continuing to sink, likely bringing the banking sector down with it. Hedge funds look to be a lost cause and the pension funds that invested in them will be too. To use another analogy, the levy that can be created by lowering mortgage rates has to be put in place to stop the flood from inundating the whole financial sector, it may already be too late.

This Lehman 'banruptcy' may have all kinds of new fiscal 'pumps' hidden in the details draining the rich neighborhoods. I'd prefer to depend upon a 'levy'.

[dd]

Winslow,
Regulated banking can survive if the derivatives are ring-fenced which very well may have been the real hard-nosed discussions. Netting has many meanings.

[dd]

Forget Lehman, Capitalists everywhere wonder exactly how this happened:
Bank of America Reaches Deal for Merrill
http://online.wsj.com/article/SB122142278543033525.html?mod=special_coverage

don't remember voting my shares!

[Winslow R.]

Looks like BofA is going from

'too big to fail'

to

'way too big to fail'

as fast as it can.

[dd]

So, the designated survivors are tapped to do yeoman's work but with a backstop. If the Fed can not save regulated banking then Winslow you may yet see your people's banking.

[ddt]

in the end there will be only one:

Federal Reserve Bank of JPMorgan-America
or FRBOJPMA for short

[dd]

AIG is a wild card. Outside the system but of the system. The hurricanes may overwhelm it and it may be cut lose. Depends again on the counterparty assessment but again the Fed meeting says much about who survives.

[ddt]

I'm wondering what the markets will do tomorrow. Could be a wild ride.

You have:

- Lehman bankruptcy (possible last minute deal?)
- Merrill Lynch being bought by BoA (but reportedly an all-stock deal)
- AIG potential restructuring (seems like they might be successful - buying a chunk of a distressed insurer is usually a good play. talks with KKR etc. I wouldn't be surprised to see Buffett stepping in here as it is his area of expertise)
- "The Federal Reserve is expected to expand its lending facilities in the wake of the likely demise of Lehman Brothers, taking a wider array of securities, including equities, as collateral for its loans, say people familiar with the matter." - WSJ

[Dickeylee]

AIG is asking the Federal reserve for a "bridge" loan! Fed to take equities at window! The inmates are running the asylum now.

[ddt]

Krugman:

When is not a bailout a bailout
September 14, 2008, 9:21 pm

So the word seems to be that Lehman will be liquidated — hey, no more taxpayer takeover of risk, no more moral hazard; but to cushion the markets against the shock, the Fed will start accepting lower-quality assets, such as equities, as collateral for its credit lines — hence, more taxpayer takeover of risk, and more moral hazard. Oh, kay.

By the way, I’m not sure this was the wrong thing to do. But it drives home the essential craziness of the situation.
http://krugman.blogs.nytimes.com/2008/09/14/when-is-not-a-bailout-a-bailout/

[ken]

The government allowing Lehman to go into bancrupcy is like a medieval healer bleeding a patient with leeches. Get rid of the bad blood and the body will right itself is the kind of thinking shared by quack MDs and conservative economist.

The fact is that the patient, in this case the entire US economy, cannot survive without an ever increasing flow of credit. And when the investment banks and commercial banks fail to provide credit it is like the heart failing to provide blood.

The government is the only entity that can step in and give the weakened institutions enough time to heal. It is like putting a patient on an artificial heart while blood lines are rerouted by the surgeons.

Too late now. But, Oh well, perhaps they will reinstitute the uptick rule. That would do some good. It has always been my belief that investors ought to take presidence over speculators in the process of price setting. Now it is more important than ever to get the speculators out and allow the investor time to evaluate and consider the value of their holdings.

[Dickeylee]

Alan Greenspan says this is a once in a hundred years crisis. So, like, wasn't the great depression just 80 years ago?

[Dickeylee]

I just want to know if this means the Fed will take equities from hedge funds as collateral for new money to then leverage and speculate in whatever they desire to push up and dump on the public.

[ddt]

so AIG has refused the offer of a private equity buyout in order to ask the Fed for help - what the hell?
I don't see the Fed being sympathetic to a company that turns down buyers in the hopes of securing funding from the Fed. Since when does the Fed help bail out insurance companies??

AIG May Seek Help From Federal Reserve, WSJ Says (Update1)
By Hugh Son

Sept. 14 (Bloomberg) -- American International Group Inc., the insurer seeking to stave off credit downgrades, may seek help from the Federal Reserve, the Wall Street Journal said.

The insurer has turned down a private-equity investment because it would have meant turning over control of the company, the Journal said on its Web site, citing unnamed people familiar with the situation.

[dd]

ddt, I do. AIG's derivative book is huge and it's pissed as it was not extended an invitation to the Fed Sunday Brunch and then there are the hurricanes. Imagine AIG not paying out on the insurance claims and imagine it using that leverage to get in on the derivatives counterparty gig. Just a guess. Why should it go begging to private equity, the beast that started the mess way back in the 1980's?

[Dickeylee]

From the Fed's press release:

...The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.

Could one of you smart economists please please tell me what tri-party repo is? Will the Fed take title to my double wide as collateral now?
Are we turning into Argentina?

[gordon]

Looks as though people will need to start worrying about the real economy again soon, and stop throwing good money after bad trying to bail out the existing financial system.

[Dickeylee]

The Republican agenda of Bankruptcy and War...with Bankruptcy Argentinian style!!!

[dd]

Dear Tyler:
The irony: "Too Few Regulations? No, Just Ineffective Ones"
http://www.nytimes.com/2008/09/14/business/14view.html?ref=business
Or perhaps it was too few effective enforcers and a lack of a will to enforce due to political considerations and a few lobbyist dollars. But here we are at the breach, not once more into it as anyone with the vital to march forward was discarded long ago in the name of political expediency, self-interest and bush loyalism.

[ddt]

dealbreaker is killing it tonight. great coverage

[Winslow R.]

"If the Fed can not save regulated banking then Winslow you may yet see your people's banking."

Becoming a more obvious solution with each passing day :)

Though massive deficit spending is a much more obvious fiscal solution which would delay a transition to a stronger monetary policy tool for quite a few more years, as in Japan.

It's amazing but promarket forces could unintentionally bring down the current global central bank centered financial system. A zero interest rate policy, which weakens central banks, does not provide everyone with equal access. Equal access (not just for corporations) strengthens monetary policy.

A 'Coup d'état' of monetary policy is being led by 'inflation nutters'. Our current monetary policy tool leads to the zero bound and current fiscal policy seems only too willing to help.

[Bernard Yomtov]

Mark,

I very much appreciate your gathering all this together.

Thank you.

[Scott]

As an Econ undergrad student, I feel like many of the things I've learned in the last 2 years may be be out of date by the end of this year at the rate things are going.

Oh well...at least I'll have an interesting topic to write my senior paper on next spring?

[Dickeylee]

Another thought on AIG, didn't they switch their incorporation to the Bahama's several years ago, to avoid taxes? And now they want a Fed loan?

[anne]

Bernard Yomtov:

Mark,

I very much appreciate your gathering all this together.

[Right.]

[anne]

Dickeylee:

Another thought on AIG, didn't they switch their incorporation to the Bahama's several years ago...?

[Right.]

[ddt]

dd, this commenter at db basically summed up what I would have thought re: AIG

"Posted by guest, Sep 14, 2008 10:16PM
Fed cannot lend to an insurance company

Insurance companies are regulated at the State level...there is zero Federal oversight of insurers (outside of IRS or SEC)....sorta sleazy but true

NY State Insurance Commissioner regulates AIG, they have a state guranty fund that would gurantee Insurance Policies for grannies and orphans....not CDOs for Gordon Gekkos.

The Fed might bless some nonsense netting session, zero $$$$$$$$$$$"

but it is true that all bets seem to be off, so I could see the Fed stepping in, although I think it would be very strange, given that they were struggling to put together a deal for Lehman rather than bail it out, and it sounds like AIG just refused something similar

[dd]

At this point the Fed can lend to any entity it pleases. This is the emergency. By now one hopes Geithner has a reasonable assessment on the derivatives front and can make some reasoned judgments.

[esb]

The Fed's balance sheet is about to become the biggest joke in the history of central banking.

And for those of you who own BAC as of Friday last, you have my sympathies. You own a piece of a company whose management has offered to buy something for $29 that it could have one or two weeks later for $2.90 or $0.29 (or perhaps even for nothing).

And if the PBoC decides to make its move, tomorrow is the "appropriate" day. Some hints came out of one of its consultants Friday.

I continue to think of that infamous FNM radio ad, "we're in the American dream business."

Some dream.

[Matt]

The ripples are already spreading.

Why? Well, "due", and "diligence", do not seem to be principles or functions being exercised right now. I pick massive shareholder revolts at AGMs and colossal impugning of Boards' actions. Unless it all turns out to be fabulously successful. Probability of that? Slim to nil. Lehman's credit event in CDS market, anyone?

Does no one else think there's been a massive corporate governance failure in this weekend special?

Track ASX and NZX until 11:59pm and then draw conclusions about the London opening.

The Fed taking fin equities as collateral is really the kicker. The total hallucination is now complete.

[Bruce Wilder]

From the NY Times: "A.I.G.’s extraordinary move of reaching out to the Fed for help may spur other non-investment banks to try a similar move. Companies ranging from General Electric to GMAC have been hurting badly and would desperately love the liquidity that the Fed would provide.

"Yet it isn’t clear whether the Fed would acquiesce to A.I.G.’s request."

Same problem as faced by Lehman. Just as Merrill would have been in line right behind, GE and GMAC would be in line right behind AIG.

We're in the whitewater now, boys. Yippee!

[esb]

This Fed will lend to whomever it wishes against whatever it wishes (and perhaps eventually even against nothing).

This is the rule of authorities run amok, the rule of "whatever it takes."

There is no longer a rule of law in the USA,

and there is no longer any ability to vlaue anything (in dollars) for a period longer than the end of the current week.

Greenspan is correct, a once in a century event,

perhaps a "once only" event.

[dd]

esb, above all I'm an American and today there is little pride in the mess that has been made; but I will (like an idiot) support American banks because I understand financial intermediation. Despite Tyler's rantings I believe that we can and will re-regulate. We must integrate financial innovation in a way that benefits the system and all participants. Either that or Winslow's people's banking starts at 9am EST tomorrow.

[esb]

Bruce Wilder:

I have no idea with respect to GE (which I intend to buy this week if I can get my price), but I will bet you anything you wish that GMAC and GM are already on the phone (which, of course, requires the interruption of Senatorial lobbying in the case of GM).

Multiple avenues of begging, or as Bill Cara once said "suck and blow at the same time." Or was it "blow and suck at the same time."

[ddt]

Banks roll out $70 billion loan program

By JOE BEL BRUNO
AP Business Writer

NEW YORK (AP) -- A group of global banks and securities firms announced late Sunday a $70 billion loan program that financial companies can tap to help ease a credit shortage that threatens global financial markets.

...

http://hosted.ap.org/dynamic/stories/B/BANKS_PLAN?SITE=AP&SECTION=HOME&TEMPLATE=DEFAULT

[Bruce Wilder]

From the Fed: "The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market."

Section 23A restricts loans by a bank to an affiliate, asset purchases by a bank from an affiliate, and other transactions between a bank and its affiliates. Basically, it was the last barrier between insured deposits and the cannibals of Wall Street. Gone.

[Robinia]

So, do you think that rather than trying to continually shore up confidence, the Fed ought to be somehow helping to clarify that in which confidence is warranted, and that which we should not be confident in?

"It's an emergency" is not a good reason to respond with command and control, or a stand-off game of chicken. An emergency could also be met with clarity, wisdom and communication-- a voice of reason telling the people what to have hope in. Barack Obama should make a major speech on the situation tomorrow, rather than allow the situation to continue in a vicious cycle. This kind of situation calls for leadership, leadership in a positive direction. Bush is a beyond-lame duck, and will do nothing. We need some social learning, fast, followed by some legislation, fast.

Prune off the non-productive parts of the financial services industry completely, then lead toward a future that is more grounded in the economy that revolves around people's basic needs.

[Oupoot]

Why does it always seem to happen over weekends? And particularly on a Sunday? Where are the days when working on a Sunday was a social taboo?

[dd]

Robinia, spoken like a wise women. Unfortunately none were invited to the Sunday Brunch as it was a frat-fest cum Animal House Darwinian meltdown featuring a WWE cage match between The Gorilla and The Hammer.

[Winslow R.]

Brad Delong wrote:

"It seems to me that this is the right thing to do--as long as the Fed can borrow from the Treasury, that is, so that it can conduct its own operations on a properly-large scale. The Fed's portfolio is large. It is not infinite."

What is Brad talking about?

What does the Fed 'borrow' from the Treasury?

"The Fed's portfolio is large. It is not infinite."

Huh?
The Fed's portfolio is as large as it wants it to be (even infinite as denominated in U.S. dollars) given its willingness to offer loans in exchange for collateral of any quality it determines and at any interest rate it sets.

Fed lending does not add to government deficit spending unless the colateral defaults. This is the reason why the Fed should only lend reserves against government tsy secs.

[Winslow R.]

Dean wrote: "When he said that, "This is a once-in-a-half-century, probably once-in-a-century type of event," it might have been worth pointing out that he was the arsonist who created the conditions for the extraordinary set of events hitting Wall Street. "

Sorry Dean, your not being fair on this one. If you believe a chain of events led to the current problem then you need to give Greenspan the option of going back one more link in the chain.

That link is Brad Delong in the Clinton administration urging Clinton to wipe out the federal deficit, sending the economy into recession. How was Greenspan to control monetary policy without any reserves? Sure he could pull a Bernanke and accept any and all collateral but it was so much more acceptable to ask for tax cuts, war, and then lower interest rates.

Of course we then can give Brad the option to blame his professor that taught him government deficits were so bad even if well invested.

[dd]

Reuters reports Leh filed for bankruptcy; no subsidiaries. So C11 filed for holding company but what about b/d (Spic covered) which is a C7? Interesting, still a play here maybe.

[dd]

Sorry meant SIPC..securities investor protection corporation

[Winslow R.]

Brad S. wrote "But rather than worrying about the rest of the world, the US authorities now are worried about the health of the United States’ own financial system. "

Careful with the analogies Brad S. as these debts are all denominated in U.S. dollars. Payment on these debts by the U.S. government is only politically constrained.

[SanFranciscoJim]

How predictable you are Winslow, I knew some Republican would come on here and say "But.. But... But... It's Bill Clinton's fault!"

The real problem is here is the massive deregulation of the financial services industry, paired with the nod-non-wink-wink approach of the current Administration to regulation.

The massive budget deficits of Reagan and the twin Bushes haven't helped either, as we are now pinned into a corner with no ability to borrow as needed to get through this.

[Ryan]

"I truly fear for our economy and our system the next
several days."

Days? Try months/years.

[Barkley Rosser]

With AIG running to the Bahamas, that does increase the irony of them apparently being done in by global warming, if we can indeed ascribe the more intense hurricanes to that cause (somewhat debatable).

So, the period of financial distress is reaching a new potential breaking point. And Donald Luskin was just in WaPo today assuring everybody that housing prices have been going up since February. No problem! All of this is just a propaganda plot by Dems to undermine the wondeful record of the Bush administration!

[Winslow R.]

SF Jim wrote: "How predictable you are Winslow, I knew some Republican would come on here and say "But.. But... But... It's Bill Clinton's fault!""

Huh? You don't come here often. STR must be laughing right now.

Reread what I wrote and understand, please. Some Democratic economists believe government deficits are bad are a danger to the economy that should be paid off during good times. The 2000 election wouldn't have been close if we weren't entering a surplus induced recession.

These same guys would destroy an Obama administration.

[Winslow R.]

SF Jim wrote: "The massive budget deficits of Reagan and the twin Bushes haven't helped either, as we are now pinned into a corner with no ability to borrow as needed to get through this."

Yes, you too are part of the problem as you don't understand monetary policy as there is plenty of 'ability'.

[Question]

Wouldn't it be great if Thain, now relieved of his ML duties, stepped in as Godfather regulator to regulate this mess of a financial industry?

[SanFranciscoJim]

Yes, you too are part of the problem as you don't understand monetary policy as there is plenty of 'ability'.

Uh huh. Demonstrate to us your masterful knowledge of monetary policy now by explaining to us exactly who is going to lend to us now. And what the consequences of a Treasury default would be.

Some Democratic economists believe government deficits are bad are a danger to the economy that should be paid off during good times.

You mean like Keynes and Galbraith? Those Democrats?

[Winslow R.]

"Uh huh. Demonstrate to us your masterful knowledge of monetary policy now by explaining to us exactly who is going to lend to us now. And what the consequences of a Treasury default would be."

Kind of snarky aren't you? Treasury default?

Given the printing press, a Treasury default is not a problem. Inflation could be the consequence and in some people's minds it is a form of 'default'. Inflation would by no means be a guaranteed consequence of a bailout.

The current Galbraith is Post-Keynesian.

http://www.moslereconomics.com/support/

Perhaps you should 'update' your thinking?

[ekzept]

Like many, I've been following this drama the past couple of weeks and today. I think the coverage here has been great.

One thing I believe I read somewhere today which, if were true, might mean another Big Cloud on the horizon is that the Federal Deposit Insurance Corporation (FDIC) has but 2 months of assets left to cover draws at the present rate. I don't know if that's true or if I got it wrong. I also don't know the relationship between FDIC and the Treasury and whether or not it is like the Macs' relationship before they were nationalized.

But, clearly, should even rumors get out that FDIC is at risk, this might panic many.

Hoping I'm just wrong.

Thanks.

[Lafayette]

Sic transit gloria mundi

Article: And, in the end, Mr Fuld's pride and obstinacy stood in the way of Lehman's desperate efforts in the past half year to right itself...
He had devoted so much of his life and his personality into moulding the bank he could not accept its decline. If he had sold out earlier, Lehman might have survived but he was too proud. It was hubris, followed by nemesis.

So sad, so sad.

Once again we see that Financial Services has a large attribute of greed feeding the rot. Instigated and prompted by a taxation system that allows individuals to accumulate hallucinatory riches.

Put marginal tax rates at confiscatory levels beyond a certain threshold and we tame the greed. If we leave them as they are, this situation will be provoked time and time again.

In America's highly competitive society, where solidarity has little meaning, then greed takes wings. Life becomes a pissing contest between males who cannot contain themselves. They MUST show how they can piss the furthest, grab the Golden Ring, be listed in Forbes amongst the world's richest.

And, for that transitory glory, we all are going to pay the Piper.

[a]

"The politics of intervention are bad, but the economics of a major crash are much worse."

For me this is the crucial false assumption - that intervention will stop a major crash. It is a faith in governmental financial and monetary engineering as hubristic as the faith in the IBs in their own financial engineering. IMHO intervention is a case of throwing good money (and the money of the taxpayer) after bad.

[rufus]

Winslow R. says...
"...Some Democratic economists believe government deficits are bad are a danger to the economy that should be paid off during good times. The 2000 election wouldn't have been close if we weren't entering a surplus induced recession."

This is simply not correct. Simply stated, US Govt demand for credit to finance budget deficits is not innocuous.

[SanFranciscoJim]

The Fed does not have unlimited resources, they have a bunch of Treasuries that they have been lending out to banks, in return from lesser quality securities. Eventually they will run out, I don't know the exact number of what they have left. Less than $500B. Googling for it did not give me the answer, but I am sure DeLong knows, if you ask him.

They can "fire up the printing presses" if the law is changed to allow them to do so, I guess, but how do they get that money into the economy? Give it to someone? Who? I don't think you understand how the money supply works.

[BJ Feng]

What is happening to these investment banks is akin to an old fashioned bank run. These investment banks are highly leveraged, if confidence falls for whatever reason, then people will stop doing business with them. Hedge funds will stop using them to execute trades, and the funds will transfer their money and assets to a safer institution. Once word gets out that Hedge Fund X pulled its business, others will follow in a snowball effect. There's simply no way for Lehman to survive once confidence evaporates and no one wants to do business with it.

This is very similar to the bank runs we saw in the 1930's. A solvent institution could be forced into bankruptcy by fear and a run on assets. The FDIC stopped retail bank runs as people don't care as long as their accounts are insured. I have a Washington Mutual account, I would have withdrawn all my money weeks ago if not for the FDIC guarantee. There is no such thing for investment banks, (and there probably shouldn't be one either).

Another aspect of this crisis has to do with the "mark-to-market" rules set up just recently. In times of great fear, securities can be traded for a ridiculously low value. No one wants to jump in because of the fear that the securities will drop further, plus there are only a few institutions with enough money to buy. Most are trying to deleverage themselves and want to sell, not buy, even at firesale prices. Mortgages are backed by real property. That property can fall in value, but 10 to 20 cents on the dollar? True, some CMO structures are leveraged, but I believe the actual recovery values will be much higher. Yet firms still have to price their assets to "market" meaning that they'll take unrealized loses and have to raise more capital. Raising more capital is impossible in this type of environment, you pretty much have to give away the company in the process.

This is what happens to leveraged firms in a market meltdown. All the investment banks including Lehman and Merill tried to deleverage as soon as the writing was on the wall. They've been deleveraging for nearly a year now, but it was already too late. You have to deleverage BEFORE the writing is on the wall, thanks to mark-to-market, it's impossible to delever. If you start selling assets to delever, the price drops for those assets, and your remaining assets have to be marked down, which forces you to raise more capital.

I think that government regulators were too lax on the amount they allowed firms to leverage. Merill, Lehman, and Bear Sterns all were leveraged in excess of 30x their equity. Yes, part of the problem was that there was no data available for the new "exotics" in a serious downturn. They are too new for that. And all the computer models were wrong. So can they really be faulted? I'll have to give that more thought.

[BJ Feng]

SanFrancisco Jim, can the Treasury just sell Treasury bonds to the FED? The FED would buy those bonds with Federal Reserve Notes, backed by the very bonds they are buying (Federal Reserve Notes have to be "backed" by US-Treasury debt obligations by law). The Treasury could then use the Federal Reserve Notes to pay for operations or fund government programs. I think this is called monetizing the debt, but I'm not sure how often this happens. I know that the FED doesn't charge the US Govt. interest on the bonds it holds, and they've amassed quite a hoard of Treasuries if $500 billion is only half of their holdings. Does anyone know if the FED buys bonds directly from the US Treasury in practice?

[Dickeylee]

BJ says, "can they really be faulted"? WTF!! Their computer models couldn't foresee this? WTF! They created the "exotics" in their black little greedy hearts, and deserve everything that happens to them.
So when is the FBI going to step in and start arresting these crooks?

[BJ Feng]

By they, I mean the government regulators. Of course the firms that engaged in these exotics are responsible for their own demise, the question is if the regulators deserve any criticism? Without the knowledge of how these new products would behave in a down housing market how would they justify an action? Such an action to limit the leverage of investment banks would need a reason, and since the exotics had performed very well until recently, what could they go on? The investment banks could point to the past decade of statistics backing their models, and say their risk levels were appropriate.

Wasn't there the stat that overall median home prices had never fallen more than 10% since the government starting tracking or something like that? Anyway, this housing bust is unparalleled in modern history. I don't know if this is going to be worse than the Depression, but Shiller believes the drop in housing prices will be greater. But anyway you look at it, the numbers on some of the mortgage pools are just amazing.

Washington Mutual's 2007-OC1 made up of Alt-A mortgage loans had in March,

* 25.3% 60 day delinquent or worse
* 13.35% Foreclosure
* 4.44% REO

And 92.6% of this pool was rated AAA before the numbers started to come in. My God, 13.35% ALREADY in foreclosure for a 2007 pool? More than a quarter 60 days delinquent? And Lehman's mortgage pools weren't much better. Yes, I'm pretty sure their models didn't predict this, but could the Feds have moved without the evidence? By March, by the way, it was too late, you have to deleverage before the boom ends and people see the stats above.

[bakho]

BJ- The housing bubble and its deflation has been discussed a LOT during the past 4 years. Median home prices never falling more than 10% was always a function of not generating the mother of all housing bubbles. The prudent investor would have hedged against the impending housing price collapse. If investment managers were too narrowly focused to understand the risks, they were over-paid.

[Winslow R.]

SF Jim wrote: "They can "fire up the printing presses" if the law is changed to allow them to do so, I guess, but how do they get that money into the economy? Give it to someone? Who? I don't think you understand how the money supply works."

Let's be clear, as the line between fiscal and monetary policy has been blurred if not obliterated.

The printing press is used to print paper dollars that are demanded by those wishing to put 'reserves' into their pockets. Bank deposits do not end up in your pocket, reserves do. Pull one out and read it.

As we've seen the Fed has only 'lent' reserves, so far, against a variety of collateral. As soon as they lent reserves on collateral beyond tsy secs, they stepped over the line (into fiscal policy) as far as I'm concerned as they started making political choices on what assets are favored assets (something congress/president should do, not the Fed). Some will argue that these loans are not purchases but they are ignoring the benefits that accrue to those that are able to issue debt acceptable by the Fed. Someday these loans, by default, could become Fed purchases.

As far as fiscal policy is concerned, the government/treasury spends money everyday. They also sell bonds to 'sterilize' these purchases. Selling bonds does not remove these 'future tax obligations' from the system. They are simply shifted from non-interest paying reserves to interest paying reserves. Taxes destroy reserves.

The government/treasury can spend as many reserves as it politically desires. The monetary tool has failed, though through fancy acrobatics, Ben is still keeping the system functioning. We need a stronger monetary tool that lends direct to U.S. citizens who can be held accountable for their actions instead of foreign corporations who can't be held accountable.

The Fed already has the power to loan to citizens, they just need to use it.

[Winslow R.]

Want to save the system?

Allow any citizen with a conventional mortgage (guaranteed by Fannie or Freddie) to refinance with a variable loan at the Fed at the current Fed funds rate.

Those that retract in horror from the thought of the huddled masses at the Fed window are simply impractical elitists.

[swells]

Well, this is making my decision to refurbish my small scale gold mining equipment and lock up a couple of small scale leases look quite prescient. Here's the next shoe to fall and the one where the hammer will really drop. Can you say Pension Benefit Guaranty Corporation?

[Barkley Rosser]

BJ,

Yes, the Fed buys government securities from the Treasury, and the Treasury does pay interest on them. However, the Fed (the New York Fed, to be precise) buys them through brokers, not directly. This allows checks to be written by the Fed, backed by nothing, that are then deposited in the money center banks that these selected brokers deal with, which then fuel monetary expansion through the demand deposit creation process, or vice versa if the Fed sells such securities and makes high-powered money magically vanish when it takes the checks from the brokers and in effect throws them away. This is how open market operations work, although in practice a majority of these dealings are not with the securities themselves but in the repo market.

[Lafayette]

Righteous Rot

WR: Taxes destroy reserves.

No they don't. They just transfer them from private to public domains.

Meaning, who determines their usage also changes. But, that's the basic idea behind all taxation.

[Winslow R.]

Laff wrote: "WR: Taxes destroy reserves.
No they don't. They just transfer them from private to public domains."

Laff, say you write on a peice of paper that you owe me $10 of Laff reserves. Once I give the peice of paper back to you due to Laff taxes, the debt no longer exists.

Perhaps I should put 'federal' in front as only federal taxes can destroy federal reserves. Though state taxes do 'destroy' state issued bonds etc.

Federal reserves are 'future federal tax obligations'. Current federal taxes destroy future federal tax obligations.

[Lafayette]

WR: the debt no longer exists

Yes, you are right, the debt no longer exists, but your reserves increase and mine decrease.

Reserves are not destroyed, just transfered.

[Winslow R.]

Laff wrote: "Yes, you are right, the debt no longer exists"

Right, and the reserves are the recording instrument of that debt. The government/Fed has no need to stockpile cash (reserves) as they can print more at any time. If you give the government/Fed cash (reserves) it is shredded. They shred their own obligations.

"The Federal Reserve Act of 1913 authorized the production and circulation of Federal Reserve notes. Although printed by the Bureau of Engraving and Printing (BEP), these notes move into circulation through the Federal Reserve System. They are obligations of both the Federal Reserve System and the U.S. government."

http://www.federalreserve.gov/generalinfo/faq/faqcur.htm#14

Laff, I want to point out that in this quote they say the notes 'move' into circulation. Just like magic they 'move' out too?

Actually the truth isn't that complicated.

The government spends reserves into circulation and taxes reserves out. The Federal reserve system is a seperate accounting system that meshes with the banking accounting system which meshes with your Lafayette accounting system.

The soundness of money is in this order
Goverment reserves
Bank deposits (especially those with FDIC insurance)
Lafayette notes

You can create an infinite amount of Lafayette notes, just like the banks (without regulation) and government, but yours are close to worthless since you lack the power to tax and have a limited ability to push people into bankruptcy to enforce your obligations.

[Lafayette]

Nitty-gritty hands on business

WR: The government spends reserves into circulation and taxes reserves out. The Federal reserve system is a seperate accounting system that meshes with the banking accounting system which meshes with your Lafayette accounting system

Thank you ... I should be asking for a higher salary, shouldn't I,for all this meshing I manage. ;^)

I can't buy this comment, but I suspect there is a grain of truth in it somewhere.

First, the Fed performs it meshing by opening credit windows, meaning it loans Treasury money. Forget the accounting. What is happening is not "spending" money for products or services, but lending money to support defined monetary policy.

The money still belongs to the Treasury, aka "the American people". We don't have a word to say on how that money is spent, because we are nerds and don't really care.

So, presidential candidates say "things that sound presidential" to get elected, then promptly put what they think are competent people into place to manage different parts of economic policy. Not even presidents know what the hell is going on -- they trust their underlings.

My point: Whatever they do to "mesh the accountings of Private Banking, Central Banking and Laffable Banking" is a consequence of policy decision making ... but it does NOT destroy reserves.

Find some other word, because "destroy" has very, very heavy connotations in this context to say what you mean. What has been destroyed, by the Fed's lack of foresight and management tact -- from this Academic Economist (Bernie) -- is the faith of American’s in “the financial system”. It is lamentable and across both Greenie and Bernie is almost akin to negligence.

En passant

Greenie was way off the mark with the dot.com boom 'n bust, and Bernie is earning the same unfortunate reputation his mentor had.

The last position ANY economist should be assigned to is head of Central Bank. Willem Buiter as Chief Economist for the Bank of England, OK. But, never was he even considered for a similar position in his homeland (Holland).

Managing central banking requires little in the way of economic qualifications -- maybe looking at the employment and interest rates once a month. Or understanding an economist when they begin a thought with the words, "On the other hand".

But, fundamentally, it is the nitty-gritty hands-on business of a financier.

PS: Somebody please tell me: Why, oh why, do we so often confuse brilliant academic intelligence with management competency?

[Winslow R.]

"My point: Whatever they do to "mesh the accountings of Private Banking, Central Banking and Laffable Banking" is a consequence of policy decision making ... but it does NOT destroy reserves."

The problem is your not looking at this in a system wide manner.

If Laff has a debt of $10 and takes in $10 his debt is not 'destroyed' as long as he keeps both accounts open.

If you 'net' Laff's worth you see that Laff's debt (negative net worth) has been 'destroyed' by him earning that $10 be it through taxation or labor output.

If you don't believe me that reserves are destroyed by taxes, what 'destroys' them then?

[Winslow R.]

Laff wrote: "Find some other word, because "destroy" has very, very heavy connotations in this context to say what you mean."

I use the word 'destroy' for its connotations.

One reason I rail against B. Delong etc. is their casual assumptions about surpluses. Surpluses can destroy an economic system based on fiat currencies as excessive taxes destroy the very money used to transact business.

I blame Brad's etc. desire for a surplus to be largely responsible for the economics ills we currently face.

[Lafayette]

WR: The problem is your not looking at this in a system wide manner.

Oh yes, I am. If one looks at this as merely double counting (in an accounting sense), then one does get confused.

It is a bit like thermodynamics. Nothing gets created or destroyed in an holistic system. It just gets transferred.

Can we agree to disagree on this one?

[Winslow R.]

Laff wrote "Can we agree to disagree on this one? "

I wish we could agree. When I first start studying economics I found it is important to understand how money is added and removed from the system. If you understand money creation/destruction it is easier to understand why some actions more inflationary than others.

You seem to have a broad framework which seems to be missing these key components. If you believe you do have these components in your framework, I'd like to hear how you think the system works :)

[Lafayette]

Thermoeconomics

WR: If you understand money creation/destruction it is easier to understand why some actions more inflationary than others.

I have training as an engineer and been taught the laws of Thermodynamics . This gives me an insight into energy; which is never destroyed, just transformed and transferred.

I'll stick with that appreciation of value (aka money), thank you very much. We have different accounting rules -- that's all.

In fact, if some brilliant economist can understand and explain economic entropy , s/he will hit upon something that unlocks an understanding of how our economy works. This field of work has already started and is called Thermoeconomics .

[Winslow R.]

I too have studied thermodynamics, and see the 'real' economy of mass, energy, and entropy in constant conflict with the 'unreal' financial economy.

The interface between the two systems boils down to how humans value money versus services/things.

The conflict arises as the human valuation of services/things rises or falls in relation to the value of money.

When these swings in valuation don't sync we have inflation and deflation.

Why real things/services and unreal money don't sync has to do with supply and demand in both systems.

You understand how the supply/demand of things are created as you understand thermodynamics, now you need to understand how the supply/demand of money is created.

To make thermoeconomics work requires the money creation/destruction process to match perfectly with the real economy's creation/destruction process. Why not the reverse? Money is much easier to create/destroy than real things.

Economists have a hare-brained idea that the Taylor rule does the trick given the current monetary mechanism. I have yet to hear Mark or any other academic economist, admit the current monetary mechanism is broken.

To fix the monetary mechanism, the production of new money must be tied more closely to the part of the economy that is actually producing things.

Currently we have a financial sector that distorts the money creation process so that it has little relation to what is happening in the real economy.

The financial sector would like to keep you stupid as it can be very profitable. I say we need a redesign from the ground up.

[Lafayette]

Some guys just need to have the last word. You've had yours.

Do you feel better, now?

[Winslow R.]

Laff I'm just trying to learn something here. If you haven't, sorry perhaps I've wasted both of our times.

I'll stop trying now :)

[Lafayette]

WR: To fix the monetary mechanism, the production of new money must be tied more closely to the part of the economy that is actually producing things.

Currently we have a financial sector that distorts the money creation process so that it has little relation to what is happening in the real economy.

I can agree with the above. It is good common sense. So, let's just carry on from there.

My point: We tend to point our fingers to blame the Golden Boys of Finance. They were only indicative of the rot -- i.e., the mindset that is ingrained in personal greed. That is, well a little is GREAT so a lot more should be a LOT GREATER! That is a non sequitur.

The challenge of present day America is in changing that mindset. The economy will take care of itself. What is needed is a sociological remake of the American mindset by which "anything goes" because such is consonant with our basic precepts of "liberty".

Liberty was never meant to bankrupt a nation. Liberty yes, but Financial libertinage, no.

Most importantly, we are at a crossroads. If this mess had to happen, rather that it happen in a presidential election year. We had better make the right choice in November, because the destiny of the nation quite likely depends upon the Chosen One.