By Greg Hunter’s USAWatchdog.com
If there is one central theme to the ongoing financial crisis we face, it is an insolvent banking system. It is so bad that the accounting rules were changed (after the financial meltdown in 2008) to allow banks to value assets on their books at whatever they think they will fetch far into the future. So, the billions of dollars of underwater mortgage-backed securities and real estate sitting on the balance sheet is held at imaginary values to make many banks look solvent when, in fact, they are not. This is opposite of the way the IRS values assets. The price of something is based on what the asset is worth today. This is called mark to market accounting.
If any of the banks (especially the big banks) want to prove me wrong on this point, then they can simply value all their assets for what they can get for them today and the argument is over—fat chance! I never see this subject ever brought up when the president of a big bank is interviewed. I’ll bet you Jamie Dimon of JPMorgan would really squirm if he was asked what his bank would be worth if all the assets on the balance sheet were valued at today’s price.
In January of 2009, I wrote a piece called “Default Option.” I had the crazy idea that the big banks should be taken into receivership. Yes, shareholders and bond holders would have been wiped out. Tough—that’s investing. The only people you would have to protect are the depositors and, at the time, it would have cost $6 trillion. I said, “Letting those banks take the hit for their ill-advised, reckless investments based on greed will do many things. Here are just a few. Letting the reckless banks fail will limit taxpayer exposure, preserve our capital and our credit rating as a country. Bank failure will wash bad debt out of the system once and for all and protect the dollar from free fall. Finally, I think in the end it will be cheaper and more effective than what has and will be done in the future to “fix” the credit crisis.” (Click here to read the original Default Option post.)
Fast forward to today, and we see the dollar is falling, gold is spiking and the credit rating of the U.S. has been cut. My plan was downright miserly when you consider that the Fed (according to a recent GAO report) spent $16 trillion bailing out the world, with $5 trillion going to foreign banks alone. If you really want jobs in this country, you need capital formation not–debt formation. Capital invests in productive assets, and productive assets create real jobs! We still have a crippled banking system despite spending trillions of dollars, and there are still no jobs!
Money manager Barry Ritholtz of “The Big Picture” blog wrote last week, “The US banking sector is not healthy. There is a fundamental misunderstanding about the Wall Street bailouts amongst the public, and quite a few policy makers at Treasury and the Federal Reserve: Somehow, they “fixed” the banking system. All it took was few trillion dollars in liquidity and a few $100 billion dollars in recapitalization, and all is now fine (I suspect some people at the Fed know the Truth). In fact, they did nothing of the sort. The banking system was not saved; the massive injection of liquidity temporarily salvaged the day-to-day operations of banks, but they did not repair what ailed our financial institutions. Indeed, pouring billions into nearly identical management teams that mismanaged the risk, over-leveraged exposure, and drove banks off the cliff in the first place was an invitation for another crisis. And that crisis now appears to be arriving. And, it’s our own fault.” (Click here for the original top notch post from Ritholtz.)
This next crisis will be even worse. For one thing, institutions like Bank of America are being sued with allegations of “massive fraud” for selling toxic mortgage-backed securities. And it is not just B of A being sued. Investorguide.com said earlier this month, “These lawsuits are sweeping through the industry at an alarming rate, with no less than 90 active lawsuits over mortgage bond losses asking for approximately $197 billion – which could cripple some major financial players quickly and consolidate the industry in unpredictable ways.” (Click here for the complete Investorguide.com story.)
For another thing, the money dumped into the financial system is causing inflation to jump. Look at the price of food and energy. The next bailout will dump even more funny money into the system, and gold will be sent sailing past the moon on to Mars right along with inflation. Unemployed people with no money don’t need things to cost more, but they will.
Mega money managers Mark Mobius and Ray Dalio also say nothing is fixed. Both predict and say another financial crisis is on the way. Dalio, who manages around $100 billion, gives an end of 2012 or beginning 2013 time frame. In closing, two years ago I said, “Right now the “default option” is voluntary, but if we get this wrong and do not really fix this problem, then default may be forced on a lot more people than just the incompetent bankers.” It looks like we did get it wrong, but that doesn’t mean the system will not get fixed. It is just going to be a lot more painful than it needed to be.