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Archive for October 22nd, 2010

‘Derivative Markets’ and how three presidents used them to screw all of us

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from: http://www.w3f.com/patriots/derivatives.html

Derivative: A financial contract whose value is based on, or “derived” from, a traditional security (such as a stock or bond), an asset (such as a commodity), or a market index.

A LITTLE STORY to explain how derivatives work, how it could happen, and how it affects us all:

Susan is the proprietor of a bar in Detroit. Susan realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar.  To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting these ‘special’ customers unsecured financial loans).

Word gets around about Susan’s “drink now, pay later” marketing strategy. As a result, an increasing number of customers flood into Susan’s bar. Soon she has the largest sales volume for any bar in Detroit.

By providing her customers the freedom from immediate payment demands, Susan gets no resistance when, at regular intervals, she then substantially increases her prices for wine and beer, the most consumed beverages of ‘the people’. Consequently, Susan’s gross sales volume increases massively, and she hires more employees too.

A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Susan’s borrowing limit. He sees no reason for any undue concern, since he has the debts of all these unemployed alcoholics as indirect collateral.

Financial institutions were pressured in the late 70’s to promote high risk securities (bonds) and loans by the first president (1) who wished to gain the votes of unemployed alcoholics. Promises of easy, unearned money garnered their votes as he was overwhelmingly elected by those hoping they could get some of this easy money. It was successful, he got elected as a representative of ‘the little people’.

At the bank’s corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS for all bars, such as Susan’s. These securities are then bundled and traded on the international security markets. Naive investors don’t really understand that the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics.

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Bernanke’s Declaration of Independence

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by Gary North
Originally posted October 9, 2010

Ben Bernanke gave a grim speech on October 4th. It did not get media attention. That was because it was so grim.

IT WAS ON THE LOOMING FISCAL CRISIS OF THE FEDERAL GOVERNMENT. THERE WAS NO EASY WAY TO AVOID IT, he said. Congress has to decide what spending to cut. This means that Congress must decide which special-interest groups to alienate. Then it must decide which taxes to raise. Whose ox will get gored? Congress has been deferring this two-part decision since the Nixon Administration.

The essence of politics is buying votes with the taxpayers’ money, but without losing more votes than you buy. That is to say, there must be deception. Each beneficiary must conclude: “I am going to get more out of this than I am likely to pay into the system.” They all cannot be correct about this. So, the tax burden is concealed. There are two other factors of concealment: increasing deficits and increasing monetary expansion.

Here is where Bernanke is firing a warning shot across Congress’s bow. His speech is a warning to Congress that the Federal Reserve will not take the hit. It will not destroy the dollar in order for Congress to play its game of deception.

This was Bernanke’s Declaration of Independence. The media did not pick up on this. I don’t think Congress did, either.

I am going to take you through the speech. As you read what he said, keep asking yourself this question: “What is he trying to tell Congress?”

He made it clear that Congress cannot maintain its present course. The markets will not allow this. He said that there will be a day of reckoning: rising interest rates. At some point, lenders will decide that the United States government is no longer a reliable borrower.

This warning goes to the heart of Congress’s deception procedure. He said that interest rates will rise. But everyone can see that rates will rise on a vastly expanded level of debt. The deficits keep pushing up the total national debt. The interest rate burden is minimized today because interest rates are at lows not seen since the Great Depression. It does not cost much to roll over the debt.

This is true in the private capital markets, too. Borrowers can expand their level of personal debt because their monthly debt repayment schedule is reduced by lower rates. This lures the public into more debt. Bernanke mentioned this briefly. He can see what is coming. When rates rise, they will cut back on new debt and more purchases.

He told his audience that the escape hatch of ready lenders is going to be shut. The lenders will reduce their purchases of debt at low rates.

This is another way of saying that the AAA rating of the U.S. government will fall. The idea that you cannot lose by buying Treasury debt will go the way of the dodo bird. This was a major statement by the FED Chairman. It went right to the heart of Congress’s deferral of the day of reckoning.

His point was that one of the two exits will be closed by the free market. The lenders will close it. They will do so out of self-interest. This will leave only one other exit: the willingness of the Federal Reserve System to buy Treasury debt. He never directly refers to this.

As I take you through the speech, keep this in the back of your mind: “Why is he telling this to Congress?” I can think of a surface reason: he is telling Congress not to count on the FED to bail out Congress when the lenders start saying “no.” He is saying that Congress must begin to impose the cuts in the future, because the FED is going to let interest rates rise. The deception will have to end at that point.

He was telling Congress to begin to decide whose oxen must be gored.

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