Kunstler: Margin Call

"The FTSE has dropped by its largest margin in 4 years..."

From www.kunstler.com:

The seas were a might choppy off Hedge Fund Island last week after all when the Federal Reserve started tossing life preservers of ready cash to the Big Fund Boyz bobbing and thrashing in the swells. Now, about that "money" -- which is really a bunch of extended lines of credit at the Fed's artificially-low official interest rate -- what actually happens to it? The simple answer is: it disappears into the same ocean of financial woe that the Boyz are drowning in.

The mere $38 billion that the Fed tossed out Friday afternoon, as the Dow was tanking down a few hundred clicks, will be used by banks and investment houses to cover losses in the synthetic securities they themselves created, and have been trading, during this psychotic final blow off of cheap energy capitalism. In essence, the Fed is buying worthless paper. The trouble is, there is so much more worthless paper out there that all the computers at the Federal Reserve could never generate enough pixelated cash to cover them in the life of this universe or several like it.

An additional problem: there is a practically inexhaustible supply of "dead" mortgages and corporate loans washing up on the pebbled beaches of Hedge Fund Island. No matter how bad the mortgage-and-credit-derived racket looks now, it is certain to only get worse as the dead mortgages and loans fester in the sun and the tropical foliage on Hedge Fund Island starts to wilt from the toxic fumes of all that decaying matter. This summer is only the beginning of a cycle of adjustable mortgage interest rate re-sets. The numbers go way up in the fall and are scheduled to continue rising well into the winter of 2008. How long do you think the Big Fund Boys can tread water?

What you're seeing now is a simple matter of financial sector players trying desperately to evade the consequences of their own actions. The fake wealth generated by the synthetic securities they created is now being recognized for what it is: a swindle. The hallucination is over. The collective denial that supported that hallucination is dissolving. The losses are become manifest. Even worse, the losses are growing exponentially because the synthetic securities were used as collateral to leverage far greater multiples of "positions," bets, and plays in a casino-like global electronic trading arena.

This is what happens when investment gets de-coupled from real productive activity and becomes an end in itself. It has been terrifically enhanced by computer programming. But no amount of digital legerdemain --with the "sugar-on-top" of accounting trickery -- can now hide the fact that there is no "value" there. What's more, the losses are going to have to show up somewhere. If you try to suppress them in one area, they'll pop up in another. If the Federal Reserve tries to cover the losses racked up by the Big Fund Boyz by giving "cash" away, they'll only succeed in destroying the value of the cash itself, i.e. the US dollar.

Now, few reasonable people can really imagine that the Fed would blunder into hyper-inflation. But the situation is so desperate that the Fed's mission to do what's necessary to rescue drowning banks may over-ride the prudent deployment of cash life preservers. As that occurs, foreign holders of the US Dollar may detect the impending loss of value of the dollar, and there would be a stampede to the redemption windows to get rid of them. That would leave the Federal Reserve (and by extension the American Nation) in a position of stark and implacable insolvency.

In any case, the US now stands on the brink of an unprecedented liquidation of assets. The mortgaged title holders to over-priced McHouses will have to liquidate their positions as "home-owners." The over-leveraged holders of credit-card debt will have to sell their Ford Explorers, bass boats, sports memorabilia (good luck with that shit) and flat-screen TVs. The retired dentists will have to dump their stocks and bonds. The corporations will have to sell off subsidiary operations, buildings, and corporate jets. Some colleges will just shutter. The Big Fund Boys will have nothing of value left in their portfolios to sell. They will just drown. Their heirs and assigns will then have to dispose of the house in Sagaponak, the 10-room apartment on Central Park West, and the family fleet of SUVs.

The Big Boyz will take quite a few institutions with them -- the club-like banks and investment "houses" that employed them and went along with their mendacious shenanigans.

The upshot is that we are going to find ourselves a poorer nation. There will be far fewer people with money. There will be far fewer buyers of repossessed McHouses, bass boats, etc. Even the houses in Sagaponak and the Manhattan apartments will go cheap. The effort to pretend our way out of a financial crisis will fail. Sooner or later the recognition will set in that all that "boo-yah" was dreamed up. The United States swindled itself. We became a nation of such greed-crazed clowns that we committed financial suicide in an orgy of self-deception.

Anyway, that's how I see it this morning. The equity markets open in a half hour or so. The mood out there must be dark. The hands that hold the Starbucks cups must be trembling at the trading desks. I hasten to add that I think the turmoil and destruction can go on for quite a while. This slow-motion train wreck is not going to play out in just a week or two. And in case anyone forgets, in the background looms another storm at least as potent as the one now blowing through the financial markets: the gathering permanent global energy crisis (a.k.a. "peak oil").

Just because some Big Fund Boyz liquidated their positions on the oil futures market last week to try to cover their losses elsewhere does not mean that price of oil is going to keep going down. It may rest on the ledge in the $60 -$70 range for a spell, but you can be sure it will take flight again. And if it does as the dollar is crashing for other reasons, this will become a pretty disorderly nation in a very dangerous and unforgiving world.