Community | November 06, 2011 | 20 comments

The Collapse Of Our Corrupt, Predatory, Pathological Financial System Is Necessary And Positive

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Vic_Romano
Submitted by Charles Hugh Smith from Of Two Minds

The Collapse of Our Corrupt, Predatory, Pathological Financial System Is Necessary and Positive

We are being throttled by the Big Lie: we're told that if the predatory financial system implodes, we'll all be ruined. The opposite is true: the only way to save our economy is to let the corrupt, pathological and flawed financial system implode.

I was recently challenged by a contributor to write something positive, and so I decided to write about the single most positive outcome of the current financial crisis in Europe: the complete collapse of the corrupt, predatory, pathological global banking sector and its dealers, the central banks. Exploring why this is so reveals the insurmountable internal conflicts in our current financial system, and also illuminates the systemic political propaganda which is deployed daily to prop up a parasitic, corrupting, pathologically destructive financial system.

Our first stop is modern finance itself. Modern financial "products" and "instruments" are often highly complex and abstract, but the entire edifice can be distilled down to this: the system is based on the assumption that all risk can be hedged, and the difference between the initial position's yield/gain (i..e. placement of capital at risk for a gain) and the cost of hedging the risk of the wager to zero can be skimmed from the system risk-free.

That is the entire system in a nutshell, and we can immediately see the advantages of this system over traditional Capitalism, where risk can be hedged but never to zero, and the return is correlated to the risk taken on.

In modern finance, high-risk "investments" (wagers) with high returns can be taken on without worry because any and all risk can be hedged to zero, even in super high-risk wagers.

And since even high-risk positions can be seamlessly hedged to zero, then there is no reason not to borrow money to increase the size of your wagers: since you can't lose, then why not? Wagering in risk-free skimming with borrowed or leveraged money is simply rational.

Put these together and we see how a system based on risk-free skimming eventually leverages itself to the point that the slightest disruption can bring down the entire over-leveraged, over-extended system.

Why is this so? Every hedge has a counterparty who is supposed to pay off if the initial wager blows up. A system based on risk-free hedging is ultimately a self-organizing system which maximizes return by increasing bet sizes, leveraging/borrowing to near infinity and hedging every hedge as well as every wager.

This creates long chains of hedges and counterparties. Here's an example based on an asset we all understand, a house. Let's say someone buys a house for $1,000 down, something that was common in the housing bubble. That $1,000 is leveraged up to buy a $200,000 house via a $200,000 mortgage.

The "owner" of the house then buys a hedge to protect himself from the house losing value, so the risk is reduced to zero: if the value rises, the owner reaps the gain and if it declines, then he collects the payoff of the hedge from the counterparty, for example, a Wall Street investment firm.

The counterparty calculated the risk of real estate declining and then priced the hedge accordingly. There is some small risk that the loss will exceed the cost of the hedge, so the issuer of that hedge bundles similar bets and then buys a hedge or "insurance" from another player, who makes the same calculations of risk and return.

Meanwhile, the mortgage has been tranched (sliced into principal and interest and into various pools of risk) and bundled with other "low-risk" mortgages and sold to investors, who also buy a hedge against any loss in the tranch, for example, a credit default swap (CDS) which pays out if a borrower defaults. Those hedges are sold or "insured" with another hedges.

All of this debt and all of these hedges are based on a mere $1,000 of actual capital. The players who originated each hedge are similarly leveraged, because since risk can be lowered to zero, who needs capital?

So what happens when one counterparty (issuer of a hedge) somewhere in the chain runs into trouble? The entire chain collapses. With razor-thin capital to cover any losses, then each link in the chain dissolves into insolvency if their counterparty fails to pay off.

This is how we get hundreds of trillions of dollars in "notational" derivatives: every hedged is hedged with another "instrument," "products" are bundled and insured, and so on. The system is based on the principle that risk can be reduced to zero, and so there is no need for capital.

Unfortunately, that premise is demonstrably false. Benoit Mandelbrot dismantled the notion that risk can be reduced to zero in his prescient masterpiece, The (Mis)behavior of Markets. The founder of fractal geometry showed that markets are fractal in nature, and are thus intrinsically prone to unpredictable disruptions. Simply put, risk cannot be massaged away.

Thus the fundamental premise of all modern finance is flat-out wrong, and this explains why systemic risk, rather than being eliminated, actually rises with every ratchet up in debt, leverage and counterparty hedging.

The entire global financial system is thus based on the equivalent of a perpetual motion machine: money can be borrowed or leveraged into existence in essentially unlimited quantities, and then deployed in risk-free skimming operations to harvest unlimited wealth.

What does this promise of using leveraged capital to skim risk-free fortunes do to the "real economy" of production and investment in plant and technology? It guts it. The risk of industrial Capitalism is real and cannot be hedged away; high-risk investments may blow up or they may return high yields. It literally makes no sense to risk real capital in productive Capitalism when a zero-risk skimming operation can be developed that essentially needs near-zero capital.

Thus financial capital has come to completely dominate industrial or productive capital. The pernicious consequences of this dominance have poisoned the economy and culture on multiple levels.

In the political sphere, the aggregation of hundreds of billions of dollars in skimmed profits gave Wall Street and the banking sector unlimited budgets to buy political influence. This created a monstrously pathological feedback loop: the more political influence Wall Street bought, the higher their returns on financialization skimming.

Consider housing as an example. Housing was once a simple, barely profitable long-term investment for both the buyer, who had to place substantial capital at risk (20% down payment) and the holders of mortgages, who took a modest yield for 30 years in trade for low risk.

Wall Street and the banks financialized housing via political influence. opening up a vast new territory to be exploited via skimming. Since capital wasn't necessary in no-risk skimming, then down payments were dispensed with to increase the pool of debtors, as they are the foundation of all skimming operations.

the cost of servicing that debt was manipulated via "teaser rates" and "interest only" loans, further leveraging up American home buyers' modest income streams. Mortgages were bundled, tranched and hedged, and the mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) were sold to trusting investors aroudn the world.

It was a bonanza of unprecedented wealth creation from financial skimming. $1,000 down and a few hundred dollars a month for a "teaser rate" interest-only loan was leveraged into a global chain of "products" and counterparties that could be skimmed all along the chain.



Continues:

http://www.zerohedge.com/news/guest-post-collapse-our-corrupt-predatory-patholog...
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20 comments // The Collapse Of Our Corrupt, Predatory, Pathological Financial System Is Necessary And Positive

  • jubal
  • zoomy1
    • 0
      zoomy1  

    • Finally, a clear, easy to understand explanation of how we got into this mess, and who is responsible for it.

    • 1 year ago
  • squarethecircle
  • maasanova
  • freecrack
    • 0
      freecrack  

    • so sad but true.as change never comes till disaster shows its need.

      i mean really?
      how many people had to die before railroad crossings became standard?and in some places still arent?
      why would it take more than one kid falling in a well to figure out wells should all be secured.yet even after baby jessica, little bastards are still falling in wells.

      as long as we aint starving, it will be "its ok its working fine"

      cuz we need the catacalysmic mess to show those who cant think what the rest of us fore see

    • 1 year ago
  • wolfess
  • Nick19
    • 0
      Nick19  

    • I don't see the entire system collapsing rather, I see it reworking itself out as one group falls and another takes its place. The globalization aspect of the World economy will continue to move forward regardless of any sort of collapse. Whats lacking is simply the political will to both recover the current economy and to reign in the corruption that makes current regulatory agencies ineffective.

    • 1 year ago
  • PressCore
    • +1
      PressCore  

    • As a History buff, a coin collector for 50 years, I've studied the History
      of money first in the colonies, then in the USA over the past 400 years.
      I agree with the author that the financial system needs to implode of
      it's own folly before we can reestablish it on a sound footing. If you
      study the writings of the founding fathers from Jefferson, Adams,
      Franklin, to Monroe, Jackson you'll see they all held the power to
      issue currency was a vested power of the people themselves. The
      U.S.Treasury Mints alone had the authority to coin the real money;
      they also held the people's power in trust to issue the currency in
      U.S.Notes for convenience to be redeemed in Gold or Silver coin
      pursuant to the Constitution. In colonial times, currency was made
      of hemp, with the penalty of death written on it as a warning to
      forgers who'd counterfeit currency seeking to steal others' coins.

      For the first 60 years of American money, the U.S.Mints produced
      coins that would amaze people of today. Large Cents of solid Copper
      nearly the size & thickness of Kennedy half dollars. So large they
      even made 1/2 Large Cents, the size of quarters. And Large dimes.
      The citizens of the USA were respected no matter what class they
      belonged to because there was a system of weights & measures
      that guaranted an ample money supply for rich & poor alike. The
      farmers and millers knew Copper. The more affluent merchants
      knew Silver. The Bank owners knew Gold. The ratio of 2,000
      quarter sized 1/2 cents=20 90% Silver/ 10% Nickle dollars= 1
      half dollar sized Gold coin of 1 troy oz Gold alloyed with Copper
      to make it durable. Paper currency was still never trusted because
      people knew it could be easily counterfeited. It wasn't until after
      1830, when Jackson vetoed the 2nd Corporate Bank of the U.S.
      Govt. condemning it overseen by Fraudsters and Embezzelers,
      that the swuperrich encroached on the Govt to change the original
      system. By 1845, the Half cents disappeared. By 1856, the Large
      Cents disappeared. The Mint issued small thick Nickle cents people
      rejected. They replaced them with small thick Copper Indian Head
      cents in 1859, then settled into small thin Copper cents until 1982.

      After the secret agreement Banksters made on Jeckle Island in 1910,
      the foreign banking dyanasty, the Rothschilds greased Congress
      into selling them the rights to again install their Trojan Horse private
      press to print worthless fiat currency to be redeemed for Gold/Silver.
      It took this Fed " printer of last resort " only 20 years to end the issue
      of Gold coins, and 30 years more to end the issuance of Silver coins
      with their bogus debt based Monopoly parlor game Ponzi Scheme
      script. JFK defied the Fed, issuing Executive Order 11100 to again
      order the Treasury to resume issuing blue seal Silver certificates,
      and continue coining Silver in Spring 1963. After he was Murdered
      in Fall 1963, Congress again kowtowed to the Fed, phasing out Silver
      as money by 1970. Already by 1965, the Fed had flooded the entire
      world with it's bogus unbacked, essentialy counterfeit currency to
      finance the Vietman War, to establish military bases in 90 foreign
      countries. JFK tried to end the national debt burgeoning out of
      control since 1957, reign in the C.I.A. and avert the Vietnam War.
      But the military industrial complex Eisenhaur warned us of in Jan
      1961 already staged their coup over the civilian Government, With
      the Fed fueling the Corporations with fiat currency, the M.I.C. has
      been the shadow government pulling the strings since. The entire
      economies of most of the world nations saddled with a foreign
      owned Fed private bankster system are imperiled to collapse.

      These derivatives the infamous Wall St Banksters value at up to
      $1.5 Quadrillion ( 1.5, 000,000,000, 000 ) are bogus, immaginary
      money. Yet because the U.S.Government has obligated itself to
      hedge the Bankster's casino bets with the taxpayers' money, we've
      been sold down the river by crooks who can't tell the truth, and
      can't lie stright in bed. The entire world's nations economies only
      total $65 Trillion. The real " secret national debt " is beyond $66
      Trillion. The people's private debt totals over $300 Trillion. But
      the clincher is it's all immaginary money. The Fed purports to
      be able to create money out of thin air by simply making an entry
      into a ledger, then lending 90% of it for a profit, retaining 10%
      in reserve of absolutely nothing. They lend the people,& the
      Government their own money, then because they once Bribed
      the Government to permitted them to put their name on it which
      is UnConstitutional, and not their province to grant..The Fed then
      buys up REAL assets, with bogus debt based on counterfeited
      currency. This conversion & Fraud is what the m.o. of the Ponzi
      Scheme is based on. Money for nothing.

      If you watch the premiere episode of Brad Melter's Decoded 2nd
      season about Ft Knox, also watch yet another documentary from
      the History channel entitled Prophets of Doom, you'll see it verified
      on good authority the monentary system our economy is based on
      is a Ponzi Scheme Fraud, that most of the world's financial systems
      & economies are based on, ditto. As the FRS dollar is accepted
      as the reserve currency of most of the world's nations, that's easy
      enough to understand. You know how the price of Gold has been
      speculated from $600 to nearly $1800. Is expected to climb to
      $2,000, and eventualy to $5,000 ? That's happened despite the
      most stenuous efforts of the U.S.Govt to hamper it's rise in price.
      Because the greenbacks we earn & spend are so intrinsicly worth
      less that though arbitrary, Gold, as the most universaly accepted
      monentary medium of exchange through recorded human history
      is the only standard we can measure currency against.

      One financial engineer Wall St hired to devise their derivatives
      was interviewed on Brad meltzer's Decoded. He likened his ultra
      complex derivative formulation as the Manhatten Project of money
      And that when it has it's ultimate final effect, the system will implode
      and collapse. That it all depends on the rate of collapse to be yet
      determined as how things will go. If the system collapses quickly,
      then there will be panic & chaos. If gradualy then Depression.But
      he told Brad's investigative Journalist team, he's stockpiling food
      & water, and firearms because he's sure it's coming. In yet another
      news article I witnessed, the U.S.Govt is also stockpiling food, So..

      My point is simple. Noone can " fix the economy " without eliminating
      the bogus, unstable monentary basis upon which it's built. You can't
      build a house on shifting sand. It has to have a strong foundation 1st.
      I support H.R.Rep Dennis Kucinick's N.E.E.D. Act because it's the way
      to again restore the power of We the People to issue money. We have
      to take that stollen power away from Organized Crime to survive. In the
      words of the prominent 1800s orator & statesman Daniel Webster:
      " The Government makes mistakes because it's manned by people
      who are fallible. But as money is necessary for all to survive, the one
      thing the people can never, should never, will never forgive is them
      allowing anything to embezzel the public Treasury, cheating us of
      our very means to live with Liberty " www.occupytogether.org. Check it out.

      .

    • 1 year ago
  • Nick19
    • 0
      Nick19  
    • PressCore:

      Yet the system of fiat currency and the ability to control/regulate the very value of our currency has made it one of the most stable as well as most reliable around the world. There is a reason why when I go abroad to a developing nation like Honduras for example, people would rather have you buy things in dollars than in the local exchange. I find it rather ironic that the reason why people advocate gold is because it has a universal "value" as it were since the complaint against a fiat system is that nothing backs. Gold in reality is backed by our own perceived value of what it ought to be so in the end, its no different from a fiat system since humans will continue to put a perceived value on an item. Also, we simply don't have enough gold to back the ENTIRE financial system and would mean that gold would in the long run, make us vulnerable to the whim of the market since gold is no different from any other commodity. It will go up and it will go down at some point. What happens if the value goes down? Then what? What would this mean for any currency backed by gold? May I remind you that the economic situation today cannot be solved by 19th century concepts of gold and silver values due to the nature of a much larger World economy.

    • 1 year ago
  • PressCore
    • +1
      PressCore  
    • Nick19:

      I think you missed the meaning of my message. It had absolutely
      nothing to do with Gold per se. It had everything to do with restoring the
      Treasury to it's Constitutional function of issuing debt free U.S.Notes as
      currency. The 2007 Denver minted Amero was made of solid Copper,
      (which many of the pattern coins preceeding the double eagle Gold coins
      authorized after the 1849 California Gold srtike, were made of.) Copper is
      worth $4 a pound now only because of the hyperinflated devaluation of
      the Federal Reserve Note version of the dollar. If the dollar were, as it
      should be, made of U.S.Notes, then various sizes, & thicknesses of solid
      Copper coins could be exchanged for U.S. Notes of $1, $5, $10 anyway.
      And Silver for $20, $50, and $100 Notes.

    • 1 year ago
  • chew_chew
  • DanCastro
    • +2
      DanCastro  
    • chew_chew:

      I'm with you. I want US to look at how we value effort. Why are CEOs worth millions and artists worth a dollar in a hat? Why with all the natural wealth in the country is it OK for some not to have health care or food? We can change how we reward ourselves and therefore how we use money. #1 get back the Trillions stolen from US to invest in schools and tech to make the future a green place with clean energy and everybody having enough to get by.

    • 1 year ago
  • Wyley_Wombat
    • +4
      Wyley_Wombat  

    • Eventually most parasites kill their hosts, some taking longer than others. The capitalist system has just taken a bit longer to achieve this. If it had become, and it could have, symbiotic, it would not have come to this but it is following the greed driven parasitic route and will destroy itself before long.

    • 1 year ago
  • nikonwilly
    • +3
      nikonwilly  

    • It's been exposed for it's fraud and deceit...they have been outted ...we all know the corruption here...yet they are allowed to keep this game going due to our corrupt politics ...I'm willing to see if the occupy movement does anything ...but at some point we're going to have to simple refuse to be part of this corruption system...I say stop paying taxes and boycott targeted corporations until they crumble....one by one if that's what it takes.
      remember...they will never stop from a guilty conscience.

    • 1 year ago
  • kennymotown
  • Dagum
    • +5
      Dagum  

    • It's time to see the real value of everyone's labor. If the house of cards collapsed would the paper pusher on Wallstreet be paid more (in whatever currency) than the plumber on mainstreet?

    • 1 year ago
  • NiceN
  • Leen61
    • +4
      Leen61  

    • Good article. I have always thought the only way to correct this country's economic system is to let it implode and start from scratch. When these thugs have no risk and suffer no consequences, they will never do the right thing. if their ass is truly on the line, they might think twice about gaming the system.

    • 1 year ago
  • Incredulous
  • Vic_Romano
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