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Like their 19th century bank depositors, the lenders (today’s parlance corrupts the term lenders into ‘buyers’) smelled a rat and stopped accepting the paper (please note the significance of the words ‘stopped accepting’. This subtly implies the paper is ‘good’ and failure to accept it constitutes an unacceptable negative attitude.) In the 19th century banks initially backed the currency that they issued with gold and silver. But they corrupted the process by lending out the out the gold and silver they were supposed to keep in their vaults. That practice, back then, created the same hard to claim collateral that now backs all sorts of AAA rated collateralized paper. The 19th century banks used auditors to verify the gold and silver. The gold and silver morphed in to gold and silver claims on another (today we sanitize this into the term ‘counterparty’). The auditors dutifully verified the presence of gold and silver ‘claims’. Today, the rating agencies dutifully accepted the collateral pledges and award the AAA rating marking the paper as money. What we see before our eyes is simply a new story with the same very, old and well used plot. This story is all about corruption of privately issued paper script used as money. To work, those being fleeced had to possess both a believable story and one sufficiently complex to preclude all but the very diligent from seeing too much. The cloak of politically correct language acted to forbid anything bad from being said. Just like our ancestors, this generation is a victim of the same human frailty: people see what they want to see. People actually changed the meaning of words in order to believe that which was not true. To avoid the stigmatism of risk associated with borrowing and lending, issuers sold the paper script to ‘buyers’. The semantic wrapping mesmerized the supposed professionals in finance. History tells us that the public was blamed for the bank runs in good old 19th century. The public was responsible because they failed to accept bank script with hollow backing. Today is no different. When those who have funds to lend refuse to accept paper with hollow collateral, they are again being blamed as if they are stupid recalcitrant money hoarders who are causing the markets to freeze. Wow, here we have another nice metaphor: freeze. That word builds on criminal justice concept that everyone is innocent until proven guilty. The term, freeze, delicately avoids the fact that action by the lenders in the market have declared the paper to be junk and perhaps fraudulent. Never mind, let’s stay with the politically correct terminology and contrast it with reality. In today’s delicate parlance we would say that the ability of some guarantors to fulfill their obligations has deteriorated sufficiently for the counter parties to question if the guarantees will be honored. Now let’s do it in plain English: lenders think that those wanting to borrow won’t pay up. Unfortunately, when the business model fails in the light of reality, overhead costs continue. There is an old business truism: time is money. So when the legal system that enforces contract law moves at a pace that recognizes the time-convenience of lawyers and judges, people with overhead costs shrivel like a plant without water. In this mix if inconsistent systems, those who have funds find themselves well advised not to participate. As with the 19th century bank script, simply re-starting the game will not work. “Plumbing” is a metaphor many use to describe the financial system. But let’s not use water pipes as that implies the free flowing of only one type of material. The old fashioned Turkish toilet uses gravity and has no flushing mechanism. Like the toilet, I do not believe the financial system has a flushing mechanism, either. Another similarity seems to be that the use of paper not specifically made for a Turkish toilet causes acute blockage. Before people will again have faith in a blocked Turkish toilet, it has to be completely cleaned out (a very unpleasant job that I have witnessed). With the addition of funds, the FED has done the equivalent of adding water (liquidity) to a Turkish toilet in the hopes moving the clog will get the stuff moving. Those with media access, but without capital to lose may find that action sufficient. But those with capital will probably demand a wee bit more to restore their faith, and demand even more if their trust is to be restored. The situation is testing the paradigm that states: adding money can solve all problems financial. Unfortunately adding water to a Turkish toilet does not deal with the fact that someone has put the wrong kind of paper in it. The ability unclog the financial plumbing will depend upon getting rid of the paper that is clogging up the system. The cure for this century’s run on unbacked paper is the same as that required for the 19th Century bank unbacked paper script. Painful losses have to be absorbed. And, like yesteryear the pain of loss is only a minute portion of what will be needed. Faith and, then trust, has to be restored. Faith comes through the very human need to see meting out of punishment that equates to that which people have lost. The ordinary person will quite correctly simplify the cause of the problem as having been caused by bad people in high places doing wrong. So, this means some of the people in high places will have to spend to jail time for their misdeeds in order to restore public faith. Rather than break from the delicate sensibilities of the political correctness that got us here, we can find a metaphor for meeting this “ugly” public need. For those who must spend the time in a campus for white collar criminals, their servitude should be considered as commitment to public service intended to restore the public faith… and the length of the sentence could be thought of as a term of employment necessary to restore trust.
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