But I Thought It Was Just A “Panic”?

Or so we were told…

Remember, the values at which subprime mortgage bonds were trading at reflected "irrational fear" and "unreasonable expectations of default."

Really?*

As of last week, the ABX index of sub-prime mortgage debt showed that AAA-rated securities from early 2007 were trading at 28 cents on the dollar – AA was at 4 cents, near all-time lows. No one can say that $2 trillion (£1.2 trillion) of sub-prime and Alt-A debt is still trading at panic levels, exaggerating losses. The dust has settled. What we can see is that creditors will never recoup their money.

More than a year later, it is clear: There was no panic; this was a JUSTIFIED level of trading and reflects the ugly reality – the investors in those bonds will NEVER get their money back. 

They were swindled, to be blunt.  "AA" bonds trading at 4 cents and "AAA" at 28?  Remember folks, "AAA" credits are supposed to have a probability of default roughly equivalent to that of the Sun colliding with the earth.

There is not now and never was a "liquidity" problem.  The problem is, has been, and continues to be a bankruptcy problem.  Individuals, corporations and even governments are in fact insolvent.  Most banks are and were insolvent. 

Governments around the Western World have refused to do what the law demands, at least in the US: Recognize bankruptcies and resolve them.  The law in the United States does not permit such hiding of losses, at least in theory, among the banking sector.  "Prompt Corrective Action" demands that delinquencies be recognized and corrective actions mandated prior to insolvency occurring.

This was not done, and now we have a massive cover-up engaged in by The Fed, by Congress and by The Executive, pouring trillions of dollars of "new credit" into a black hole in a desperate attempt to avoid recognition of that which I and a handful of others outlined and proved back in 2007: these institutions are in fact bankrupt, investors were swindled, and tens of thousands of people in the "industry" should be sitting behind bars doing hard time for fraud.

Will we see honesty in the G20 come Pittsburgh? 

No.

Will we see instead governments claim that "it will be ok" and furiously continue to try to paper over the truth? 

Of course.

How long can it continue? 

Only until the Asian nations recognize that the consumer can’t "come back" to former levels of consumption, as they’re tapped out.  This in turn means they must develop internal consumptive markets for their products, and that in turn means the end of buying our debt as a means of sterilizing their export flows.

When, not if, that happens then entire exponential fraud game comes apart with extreme violence.

We have been given a gift – a six month (up to now) to couple-of-year (maybe) time frame in which to recognize the truth, break up these behemoth organizations, force the bad debt into the open, default it, make depositors whole and in doing so place our economy on a trajectory where debt-to-gdp will shrink to a sustainable level.

If we fail to do so before the rope runs out – and it will – our economy will collapse.  The Federal Government will be forced to contract spending to what it can raise via taxes in the current economic climate – about half of what it spends now.  Given our budget and where we spend money, this means a near-complete repudiation of Social Security and Medicare, a 50% or more cut to the military budget, and an elimination of all other federal programs.  Unemployment will rocket to north of 25%.  Our "just in time" economy will break down and there will be widespread, perhaps even critical, shortages of necessities – food and fuel.

To those who think this can’t happen: it can.  It has before to other nations, including Argentina.

To those who think that admitting to the losses and taking our medicine can be avoided forever: it can’t.  Exponential growth cannot be maintained in a finite system indefinitely.  That is a mathematical impossibility.

To those who think that "incremental changes" will fix this: they won’t.  Never mind that all the "incremental changes" we’ve made thus far are in fact going the wrong way – toward more indebtedness, not less.

As time goes on we see that more and more of the so-called "irrational" valuations that the market placed on these securities more than a year ago were in fact conservative.  The FHA now is reporting close to 8% of all the loans it guarantees are either in default or foreclosure; that number would be dramatically higher were it not for the insane step-up in issuance over the last year.  In essence the FHA is trying to paper over its own insolvency by madly issuing more and more loans, as those can be claimed "current" for a short while – until they default.

"Desktop Underwriting", that is, the FHA’s computer-based loan authorization system, is reportedly accepting loans with a 64% debt-to-income ratio.  This is blatantly beyond safe and sound limits as the borrower is essentially assured to have a negative free cash flow after paying income taxes.  (The maximum SAFE DTI, established over more than 50 years of practice, is 36%.)  This purchaser funded a near-$300,000 house with $25,000 in annual income.  Yes, that loan received formal "underwriting approval."

The fraud that used to be "stated income" in housing is still going on, now with the explicit blessing of the Federal Government’s FHA program.

Welcome to the new boss, same as the old boss, and they both called 1600 Pennsylvania Avenue home.

If we don’t stop this insanity before the market forces it on us, and it will……