The most dangerous words on Wall Street

Wilbur Ross

Chairman and CEO, WL Ross & Co

I recently overheard two men arguing about who was better off. One boasted about his new car, the other about a plasma TV and so on, until one proclaimed, "I am better off because I owe more than you are worth." The second man conceded defeat. This anecdote summarizes the mortgage bubble. Americans spent more than they earned in 2005 and 2006 and borrowed the difference. The federal government did the same. Everyone secretly feared this was unsound but wanted immediate gratification, so there was applause for talking heads who said global liquidity would make these borrowings safe. Alan Greenspan went so far as to suggest that people take out adjustable-rate mortgages.

Liquidity, however, is not about physical cash; it is mainly a psychological state. Subprime problems have consumed only trivial amounts of global cash but already have burst bubbles by shocking lenders. Clever financial engineering effectively had convinced lenders to ignore risk, and not just in subprime. A major hedge fund participated in a loan to one of our companies, but sent no one to a due diligence meeting. So I called the senior partner to thank him and tell him about the non-attendance. He responded, "I know. For a $10 million commitment, it wasn't worth going to a meeting."

When subprime issues first surfaced this spring, many major institutions said they had none, but recent quarterly write-offs show they did. They weren't lying; they just didn't know what they had. Their embarrassment has brought risk control back into vogue. It was always silly to lend to weak credits at discounted interest rates, and without documenting income and balance sheets and without appraisals. No amount of model building should have enabled Wall Street to take $100 of such paper and alchemize it into securities sold for $103. Models inherently assume a future similar to the past and therefore they fail when multiple standard deviations occur. Subprime models also did not capture ever more lax credit standards nor that real estate might suffer severe and protracted price declines, again proving that the two most dangerous words in Wall Street vocabulary are "financial engineering."

Now that we have identified the cause of the disease, how severe and how contagious is it? The present $200 billion of delinquencies will grow to $400 billion or $500 billion next year because $570 billion more low, teaser-rate mortgages will reset to market and consume more than 50% of the borrowers' income. Therefore most of the loans will be foreclosed or restructured. Probably 1.5 million to two million families will lose their homes. Meanwhile, few lenders will put mortgages on the foreclosed houses, so the prices will plummet. Despite these tragedies, total losses will probably be less than 1% of household wealth and only 2% to 3% of one year's GDP, so this is not Armageddon. However, even prime jumbo mortgages will be more expensive and more difficult to obtain.

Similar excesses occurred in corporate debt markets. Leveraged buyouts were financed with few or no restrictive covenants and with some borrowers able to "toggle," or issue more bonds to pay interest in lieu of cash. The debt-to-cash-flow ratio hit record highs, and more than 60% of junk bonds issued are rated B or lower. Only 13% of high-yield issuance proceeds was for capital expenditures for expansion--87% went for sponsor dividends, stock buybacks, LBOs, or refinancings, none of which inherently advance credit worthiness. And this exotic lending paid only 2.5% to 3.0% more interest than Treasury bonds' 5.5%. Therefore investors received only 8% or 8.5% interest on bonds that had a 25% probability of defaulting, the same ignoring of risk as in subprime.

The cause was also the same. Wall Street made $100 of these credits into tranches of securities that sold for $102 or more. Again we had securitization pseudo-alchemy creating fool's gold. The weakest 5% or so of a $2 trillion universe of leveraged loans and high-yield bonds will crater. This is only 1% of GDP, but lending standards will tighten for a while, just as they did after the telecom bubble burst.

Because of this outlook, WL Ross portfolio companies raised $2 billion this year to eliminate outside financing needs. More recently, we provided a modest $50 million debtor-in-possession financing to American Home Mortgage, the tenth-largest subprime lender, as it entered bankruptcy. Ultimately, we will make a major move into mortgages, because lending to weak borrowers makes sense at premium rates with proper due diligence and appraisals. After Japan's real estate bubble burst, we used a similar strategy to rehabilitate Kansai Sawayake Bank. It was earning 17% a year on equity after one year, almost twice the return typical of a Japanese bank.

This is really very painful for US Citizens. Paying for voted George Bush to Power in last election. http://www.businessweek.com/lifestyle/content/jun2008/bw20080627_320852.htm?chan=top+news_top+news+index_top+story - http://www.businessweek.com/lifestyle/content/jun2008/bw20080627_320852.htm?chan=top+news_top+news+index_top+story

The June 2008 Dow Crash and the coming first strike attack on Iran herald the end of dollar hegemony.

BREAK-DOW!

They say that pictures speak a thousand words, so let's start this with a picture:

Today, the Dow crashed through its eight-year support level at 11,750. There isn't much below now to keep it from dropping all the way back down to the 7,500-range. What that will do to American investor psychology and worse, consumer confidence, and therefore spending, and therefore the economy, is only too apparent.

The gold-attack on Monday obviously didn't take. Gold recovered the following day and powered up by $26 the very next day to close in NY at $911. On Friday, gold confirmed its breakout, which means there will be little holding it back - just like there is now very little that's holding the Dow up.

Unsurprisingly, the US war machinery is in full swing at this time. Troop and military asset movements into the Iranian theater are nearly complete, the Israelis have flown their practice-attack of 100-plus fighter jets over the Mediterranean, and Congress has again prostrated itself before its banking-guild rulers who want total government (and therefore banking) of all economic activity.

Congress did this by passing the FISA Amendments Act of 2008 to give retroactive immunity to telcoms spying for the government, and by proposing a resolution (the already infamous H. Con. Res. 362) by which Congress demands that Bush completely blockade Iran in order to force it to stop enriching uranium. This, naturally, is a perfect setup for unleashing the long-planned bombing campaign on Iran. Congressmen know that Iran will not accede to these international demands.

End result: We will probably get another war because of all this, just like we got one back in 2002-03 when the Dow plunged into the chasm this recently broken support level has bridged for these past eight years (see chart above).

The problem is that this time, it is a bipartisan gang of US war mongers in our Congress who all appear hell-bent on forcing Bush to attack Iran with a preemptive strike, possibly even an unprovoked nuclear first strike - something that human history so far has not had to deal with.

It is also something that will cause the US to forfeit any legitimate claims of world leadership for the remainder of that history.

The War Currency

Wars are rarely fought over national security issues, as political leaders often claim. At rock bottom, they are mostly fought over economic issues.

Iraq and Iran (if Congress and the administration get their way) are the only two countries the US has ever attacked preemptively. They are also the only two oil-producing countries that ever went off the petrodollar. The alleged nuclear ambitions of a terrorist-sponsoring country cannot be the real reason for the planned attack - because terrorist-sponsor North Korea was not only allowed to develop nuclear weapons unmolested, it was even allowed to test-launch a potentially nuclear-tipped ICBM at the US without any military repercussions whatsoever.

There goes the "national security" rationalization for this planned attack.

This fact exposes the attacks for what they really are. tools of US monetary policy. The dollar has no real value internationally, save for the fact that the now militarily enforced necessity for countries to buy dollars in order to buy oil creates artificial demand.

The euro's existence threatens all of this, now. Oil countries have a dollar-alternative in the euro, and so does the rest of the world. The euro is designed to not be quite as inflationary as the dollar is and has been. This is done by virtue of the ECB's exclusive mandate of "price stability", another word for inflation fighting.

Yet Another War Currency

Yet, even the euro carries the fiat-disease within it. Even the euro is structurally inflationary - just at a slower pace than the dollar. Ultimately, even the euro will fail, but it has served its intended purpose well: to sideline the US dollar and thereby the dollar-based US empire.

The old US dollar empire has now served its own purpose as the engine for global growth and for achieving general globalization. Like the Jumbo Jets of yore that piggy-backed the early space shuttles perform their test flights before they could finally launch into space on their own power, the US economic mother ship has now fulfilled its purpose and is no longer needed.

In the globalists' view, the US can now safely be discarded because it has inherent "flaws."

America has a constitutional system that, even though it has been successfully neutralized to a large extent, was designed to protect individual freedom, and that makes some of her people insist on them. Such cannot be tolerated in a truly globalized world. It tends to make people of other countries want to simulate the US and to insist on keeping their countries' sovereignty intact to protect their own tenuous freedoms.

In the final analysis, therefore, the euro is a war currency as well. It is a model currency, designed to centralize economic power in artificial, regional political bodies and away from sovereign national governments. It is a currency designed to abolish the nation state. It serves as the model to be implemented by other regions: North America next, then Asia and Africa, later North and South America combined, and eventually all of these regions will be forced to bow to a supra-regional, global control mechanism.

This will only achieved by more warfare - except it won't be called "war" anymore. Future military campaigns will be called "peace actions", for they will ostensibly be waged to "enforce peace" - a linguistic and conceptual contortion that rivals anything George Orwell could have dreamed up.

The Peace Currency

Gold is truly the peace currency. It needs no military to prop it up. It needs no centralized control system to regulate its supply, only the natural, ultimately decentralized controls of supply and demand. Wars may be fought over access to gold mines some day, but correct me if I'm wrong, so far this has not happened in history. Gold can easily be acquired in trade. Fighting a war over access would be self-defeating because it costs more than the potential benefit could yield.

So, the world is now faced by an America that claims it wants to "spread democracy" while using its military to tyrannize countries that simply want to sell their oil for another currency. America has become what she always claims to be opposed to: an absolute tyranny that no longer even cloaks itself. Not surprising, given the role assigned to her by her globalist masters in ushering in the preconditions for eventual total centralization.

Gold is allowed to play its limited role in all of this because increased use of gold for investment purposes, and as currency, tends to weaken the dollar-empire and strengthen other regions (Europe), and nations (China).

Americans, however, have it within their power to mess up the globalist's game plan for good. They have a chance to completely neutralize the eventual "winner" of the globalists' remaining, hand-picked presidential candidates. They have a chance to boot out every Congressman and Senator up for reelection this fall who ever voted to pass measures such as the "Patriot" Act, the Military Commissions Act, or the upcoming vote on House Concurrent Resolution 362 discussed above.

They can also fire all who refuse to vote for Ron Paul's Honest Money Act designed to reintroduce gold and silver as the peace currency.

If they achieve this victory, Congress will, for once, pay attention to their political will. Congress will then, for once, be a true check on presidential executive power. Such a Congress can then even be moved to abolish the Federal Reserve - but only if Americans start to pay attention to what power their choice of currency can convey to - or withhold from - their government.

It's all up to them.

In the meantime, gold will have unbelievable bull runs as the US Fed carries out Vladimir Lenin's instructions on how to "best" destroy the capitalist system - by debauching the currency.

Sounds logical let's see how long market forces are kept away from this.