It’s the Solvency Stupid

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July 8, 2008 9:12 am

By John Galt

There has been a lot of speculation and postulation by the Bubblevision crowd and those declaring a bottom every fifteen minutes on television and radio that the housing crisis is almost over and that as soon as lending standards stabilize a recovery will ensue. The problem that I have been screaming about and warning about since 2006 is that you can not loan money to people who do not qualify for it and you can not structure loans based on an assumption of perpetual 3% GDP growth without some risk of default. The idea that the housing market on average would continue to appreciate at the same pace as inflation was so asinine because it defies the basic laws of supply and demand. As the morons overbuilt the supply in anticipation of huge population growth (I guess they figured the baby boomers would adopt illegals right up to age 90) and the foolish concept of President Six Pack’s “Ownership Society” movement, the shallow end of the gene pool was given a blank check to buy homes, cars, Wiis and other things that no one five, ten or twenty years ago knew that they could afford.

So now that the banksters are figuring out that “oops, the government has not elected to hyperinflate to bail us out yet” the pressure is building on the sector to raise capital and declare their losses openly. The problem is they can not declare their losses openly because if they marked a lot of the paper they have to market, then they will be insolvent. Thus the quandary Ben and the boys find themselves in. They can not increase interest rates or defend the dollar without causing a complete seizure in financial markets worldwide and they can not wash out the balance sheet of the Fed without hyperinflating to monetize the new debt they need to create and buy to swap for the garbage sitting on balance sheets around the U.S.

To add to their problems is the 913 pound gorilla stinking up the guest bathroom (I know, it used to be an 800 pound gorilla but it is gaining wait eating junk food):

These same banksters created a subsidiary industry called the Cayman Islands where their hedge funds purchased not just a little but a boatload of the toxic stupidity to kepe it off their balance sheets and lure unwitting nations into buying securitized crappola.

Now people are wanting their money out of these hedge funds and if they can not get it, they are going to liquidate US equity holdings like there is no tomorrow. Despite their address in the islands, the funds are nothing more than phone forwarding operations with a post office box down there and the management of these funds might well be the same person who convinced you to purchase Indymac some 25 dollars ago.

What does this mean? Until the insolvent banks are taken out and shot or liquidated and until the balance sheets declared openly and honestly this decline shall continue. There is no way in the world the Fed or FDIC could even consider covering all of the losses investors are facing in the RMBS and CMBS markets and the phrase “no bid” is ringing through the ears of anyone who pays any attention to our markets. There is a definite hint of panic in the real money markets, the corporate bond sector, and if the default swap system fails as it should, that is when you finally might get a full blown “capitulation” that Kudlow and his Zippy the Pinhead Boys have been looking for. No matter what these people say, until we wash out the system and get rid of the insolvent players and bad paper, this fiasco shall grind on.

And with it, the retirements of many an American will be shredded, putting further pressure on the government to make them whole again. The government and Presidential candidates have pretty much figured out that yes it is the economy stupid and started considering ways to promise the baby boomers some sort of guarantee that they will not be hurt by Wall Street’s antics. In their efforts to prevent losses and make them whole, they are only going to make the situation far, far worse than it is now. And that is why we have so much more room to the downside after the elections.

If you think there is not much more room on the downside, just look at the BKX (Bankers) Index chart and Citigroup charts below; there is a lot more room and a long way to the bottom.