Destructive “D”s
eregulation
ollar
How Deregulation Led to Financial Crisis
Although this is a broad topic let me distill
erivatives
it down to a general statement. In my
ebt
mind the capitalist system works when
there is adequate oversight through
govefault
ernment regulation. For 40 years after the
evaluation
great depression the developed markets
Few people understand the seriousness of the D’s, the shifts that
have taken place or the long-term implications to their wealth.
Countless books, documentaries and movies have been dedicated
to these subjects so I don’t pretend to be able to cover them
extensively, but I will try to provide an understandable overview
of how and why we find ourselves confronting today’s challenges
DEREGULATION
I have been writing about the effects of deregulation for years.
While the baby Bush administration was searching for WMD
(weapons of mass destruction) in Iraq, their own pals (literally the
financial execs they associated with and had worked with) were
deploying financial WMDs that would have far more reaching and
destructive payloads.
It is amazing and unfortunate that the worst financial crisis
since the “Great Depression” which continues to reverberate via
the U.S. & Euro debt problems and global financial instability was
not only predictable, it was completely avoidable!
As this has been a truly “Made in America” crisis it’s worth
reviewing the lessons learned, forgotten or ignored in the USofA.
To avoid accidents
Look in the rear view mirror
before changing lanes!
In this Issue:
The Roaring 20’s:
Republican presidents Harding, Coolidge and
*
Deregulation - Hoover all distained regulation, believing that a
Eras (or is that
federal bureaucracy should have
errors) revisited
limited regulation over a country's
*
economic system. The tone of the
Derivatives
decade is summed up by Harding’s
(WMDs)
campaign slogan - "Less government
*
in
business and more
Fallout From the
business
in
government."
BOMB
*
Debt,
Dollar,
Devaluation,
Default
*
The “Roaring 20s’ was
the result when America
enjoyed the benefits of an
economic boom and unrestricted
speculation in financial markets
was rampant.
www.garycolefinancial.com
www.garycolefinancial.com
grew at a solid pace and with appropriate
compensation. Starting in the 1980s
deregulation allowed the financial sector
in particular to prosper unchecked which
led to greed, abuse and finally criminal
activity. In each decade (1980s S&L 1990s Dot.com - 2000s Derivative and
Mortgage Meltdown) the unlearned
lessons caused ever great crises.
•
•
•
•
•
Real estate promoters, including a former
presidential candidate offered seafront lots to
investors for 10 percent down. Investors snapped
up the properties. Prices skyrocketed. Much of the
land turned out to be - you guessed it -“swampland
in Florida.”
In an article in the Ladies' Home Journal titled
"Everybody Ought to be Rich," even John Jacob
Raskob, the chairman of the Democratic Party,
encouraged ordinary people to invest in stocks.
Brokerage houses lured investors into the market by
selling stock on margin, requiring investors to only
put down 10 or 20 percent of the stock's price in
cash and borrowing the rest.
Stock swindles & business frauds are commonplace.
Leading economists encouraged investors to believe
that the stock market would continue to rise.
It all ends “Black Tuesday,” October 24, 1929, the start
of the Stock Market Crash and the Great Depression
1930s: The Franklin D. Roosevelt Era:
• 3 Rs - Relief, Recovery & Reform
• Motivated by financial abuses that
contributed to the Great Depression,
laws placed limits on financial risktaking and required extensive
disclosure of financial information.
(519) 621-8535
(Continued on page 2)
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WEAPONS OF MASS (FINANCIAL) DESTRUCTION
(Continued from page 1)
The U.S.A. did not suffer a single financial crisis for 40
years after reforms were initiated following the Great
Depression. However, the progressive deregulation of the
financial sector since the 1980s has produced a number of
increasingly more serious crises, as well as resulting in
criminal activity at the highest levels of the financial
sector. Trillions of dollars have been lost by investors; life
savings and home equity wiped out; uncountable loss of
employment and TRILLIONS of dollars in bailouts paid
by taxpayers.
In the case of the most recent financial crisis, nobody,
NOT ONE PERSON has gone to prison despite fraud that
caused trillions of dollars of damage.
DEREGULATION DATELINE
1980s: The Reagan Era:
• Substantial deregulation,
• Savings & Loan (S&L) scandal: loose
regulations & lax enforcement led to
massive fraud; hundreds of S&Ls fail.
$124 billion taxpayer-funded bailout
• Four senators and Lincoln S&L CEO Charles Keating
accused of improper influence in advocating against
investigating Lincoln S&L, which collapses and Keating is
convicted of fraud
• Michael Milken, Ivan Boesky & other Wall Street execs
convicted of fraud and insider trading
1990s: The Clinton era:
• Clinton administration members and
Wall Street cronies help pass what becomes known as the “Citigroup Relief
Act,” repealing laws dating to the 1930’s which didn’t
allow Banks & Insurance underwriters to merge.
• Alan Greenspan Federal Reserve head refuses to enact
the power to regulate the mortgage industry on the grounds
that regulation was unnecessary.
• Clinton Administration, particularly Larry Summers &
Alan Greenspan help enact the Commodity Futures
Modernization Act, which bans all regulation of financial
derivatives and exempts them from anti-gambling laws.
• 2000: Dot-com bubble bursts
2000-2002: Eliot Spitzer sues 8 investment banks for
conflict of interest and recommending dot-com stocks they
thought were junk; reaches settlements totaling $1.4 billion
2000s: George W. Bush era: further
deregulation and relaxed enforcement
• 2000-2005: Investigations of Fannie
Mae & Freddie Mac (largest mortgage
lenders) reveal massive accounting fraud
• 2002: Arthur Andersen, 1 of “Big 5” accounting firms,
convicted of obstruction of justice for shredding Enron
documents
• 2003: Worldcom inflates assets by $11 billion
• Securitization of Mortgages - the Game Changer!
Traditional Lending Practices Discarded – previously, lenders
approved only loans they expected to be repaid as they held the
mortgage until it was paid off. With the advent of derivatives,
mortgages were now bundled in the hundreds and sold to
investment bankers to resell. The big 3 rating agencies (paid by
the bankers) gave AAA ratings to these products although
sub-prime mortgages (un-creditworthy individuals, little if any
equity, poor quality properties, inflated appraisals) were rampant.
Unsuspecting investors (Pension plans, Hedge funds, other banks
etc.) gorged on MBSs “mortgage-backed securities” and CDOs
“collateralized debt obligations,” which have been described as
“MBS on steroids.”
• 2000-2007: Fueled by the investment banking feeding frenzy,
low interest rates, unscrupulous mortgage brokers, appraisers
and analysts etc. who were making incredible incomes from the
development and sale of these derivatives, a massive housing
and mortgage credit bubble sweeps the United States; mortgage
lending quadruples; housing prices double!
• 2004: After intense lobbying by investment banks, the SEC
lifts the leverage limits on the investment banking industry
allowing them to gamble even more!
2005-2008: Goldman Sachs, Morgan Stanley, Deutsche Bank
and other investment banks now begin using credit default
swaps to bet against the same mortgage securities that they
are selling as extremely safe.
What’s a Credit Default Swap (CDS)? It is simply a policy
taken out on an investment that insures that if it goes bad you
are paid out and the insurance company takes the loss.
Problem is, unlike insurance on a house or car, multiple
policies by different entities can be placed on the same item.
This is where investment turns into gambling (not sure if it’s
junk) or down right deception (you know you sold junk).
• 2006: Hank Paulson, CEO of Goldman Sachs, becomes
Treasury Secretary
• 2007: Home ownership reaches an all-time high; the financial
sector starts to run out of people willing to borrow to purchase
housing; the housing bubble bursts and with savings rates at
historic lows - The PONZI SCHEME implodes!
Not many people have their name immortalized - Charles
Ponzi did. A "Ponzi scheme" has become synonymous with
wild speculation where fraud & default are inevitable.
In 1919, Charles Ponzi was a 42-year-old former vegetable dealer
with just $150 to his name.
He promised to return $15 to anyone who lent him $10 for 90 days.
His plan was to buy foreign currencies at low prices and to sell them
at higher prices. After newspapers reported his scheme, $1 million a
week began to pour in.
The scheme was too good to be true. Ponzi took in $15 million in 8
months. Problem is he couldn’t produce 50% returns in 90 days so
he just paid the first investors returns with later investor’s money.
No problem -- until the flow of new money stopped -less than $200,000 was ever recovered.
“What Washington needs is adult supervision.” - Barack Obama
(Continued on page 3)
FALLOUT FROM “THE BOMB”
2008: Financial Sector Free Fall
• Collapse of Bear Stearns & Lehman Brothers - here
today, gone tomorrow! Literally. Once the rumours (facts)
that these firms had huge positions in overvalued MBS the run was on by investors to
withdraw. At the same time lenders pulled back
their support. It took less than 3 days for the
dominoes to fall.
• AIG (a huge CDS issuer) rescued by the Federal Reserve
$85 Billion is largest private company bailout in US history
• Housing prices drop by 32% over three-year period
• Record foreclosures.
• Unemployment doubles in 1 year
• $700 Billion emergency bailout of US financial industry.
US taxpayers left holding the bag, wondering how
a few millionaires can destroy our wealth, our
equity, our economy, possibly our job ? And our
income tax bails them out!
Are the culprits who initiated all this chaos penalized? Fired
“for cause” without severance? Charged with fraud?
Licenses revoked? Jail Time? Substantial Fines?
Citigroup is typical of a world gone crazy. Even though it
lost more than $27 billion that year and had to be supported
by the federal government with $45 billion Troubled Asset
Relief Program (TARP) funds, a total of 738 people at
Citigroup received bonuses of $1 million or more in 2008.
44 people received more than $5 million.
Senior Leadership Committee” got $126 million.
2010s: The Obama era:
“Change We Can Believe In”
or “Business As Usual?”
Americans “flocked” to his “Time for Change”
mantra. When the financial crisis struck just
before the 2008 election, Obama pointed to
“Wall Street greed and regulatory failures as
examples of the need for change in America.”
However, the Obama administration has failed to act!
► Not one substantial law has been passed to regulate the
financial industry and few proposals made that have any
chance of making it to law.
► No limits have been placed on either the products or the
incentives (bonuses) that ultimately resulted in the
greatest loss of wealth in generations.
► Not one executive has been made to pay monetarily
(fines or claw-back of bonuses) or with 1 day in jail.
According to the Center for Responsive Politics, the “Man
for Change” has filled 25 senior administrative positions
with individuals who previously held executive or board-ofdirector posts with the globe’s biggest financial houses.
NOTICE A PATERN? Where’s the Change?
Why did the US abandon over 40 years of positive history
and dismiss the lessons of the “Roaring 20’s?”
More Importantly - Why not act to FIX IT NOW?!
DEBT
US National
Debt
Over the past number of years I have often
written about my concern with the levels of
debt in the “developed” nations (especially
the USA). For the first time in history the
world’s dominant economy is also the
world largest debtor.
1940 to Present
The financial meltdown and resulting bailouts, unprecedented
levels of stimulus spending (which had little effect on jump
starting the US economy), record unemployment, waging two
wars simultaneously and the continuous reduction in manufacturing advantage have resulted in alarming levels of deficit
financing south of the border.
Will someone explain how the U.S. Senate’s vote to increase
the debt ceiling (Sept 9) by another $500 billion to fund the
“job’s bill,” goes virtually un-noticed after the highly charged
and media intense debt ceiling debate only 1 month earlier!
The entire budget angst is a sham. It’s not focused on attacking the issues only political posturing for re-election. It is said
that a journey of a thousand miles starts with one footstep but
my take is that the US legislators have stubbed their toe on
the threshold before they got out the door.
U.S. tax base: $ 2,170,000,000,000
Federal budget: $ 3,820,000,000,000
New debt:
$ 1,650,000,000,000
National debt: $ 14,271,000,000,000
Budget cut:
$ 2, 100,000,000,000 over 10 years
It’s almost impossible to relate to these numbers so let’s try to
bring it closer to home by cutting out 8 zeros from each figure
and calling it your family budget.
Your Total Annual Income
Total Annual Expenditures
Amount required to go on Credit Cards
$ 21,700
$ 38,200
$ 16,500
Outstanding balance on the credit card
Your Annual commitment to reduce Spending
$142,710
$
210 !!!!
THE “DOLLAR”
“DOLLAR
On August 15, 1971, without prior
warning to the leaders of the other major
capitalist powers, US president Richard
Nixon announced in a Sunday evening
televised address to the nation that the
US was removing the gold backing from the dollar. The commitment by the US to redeem international dollar holdings at
the rate of $35 per ounce had formed the central foundation of
the post-war international financial system set in place at the
Bretton Woods conference of 1944.
Gold is limited but paper is not. This act set the printing
presses in motion resulting in a huge expansion in the world’s
supply of cash and credit. Four decades of paper money with
no limit on credit expansion have created mountains of debt in
all the developed countries.
(Continued on page 4)
“No country has ever spent itself to prosperity!" - Karl Rove
20 OR 30 YEARS OF MISMANAGEMENT CAN’T BE REVERSED IN 2-3 YEARS
Money not backed by a physical commodity (i.e.: gold) is
called a fiat money system. The only thing that gives the
money value is the faith placed in it by the people that use it once that confidence is gone, money irreversibly becomes
worthless, The history of fiat money, has been one of failure.
EVERY fiat currency since the Romans first began the practice
in the first century has ended in devaluation and eventual
collapse, of not only the currency, but of the economy that
housed the fiat currency as well. Gold has replaced every fiat
currency for the past 3000 years.
However, there is considerable discussion between the G-20
nations of a “new world order” when it comes to the reserve
currency. Many wish to replace the dominance of one nation’s
currency with a basket of world power currencies and gold. I
agree with Guan Jianzhong, chairman of Dagong Global
Credit Rating, who recently said the (US) currency is being
“gradually discarded by the world,” and the “process will be
irreversible.” A process that has seen most of these “powers”
reducing USD in favour of gold and other currencies
(including the Canadian dollar).
DEVALUATION
DEFAULT
Don’t get me wrong, I’m not saying the USD will become
worthless overnight but the erosion of its purchasing power has
been going on for decades. Fiat systems in Spain (1500s),
France (1700s), Argentina (1800s) & German Weimar Republic (1900s) to name a few all suffered severe devaluation and
collapse. The rising levels of unsustainable debt has a bearing
on the devaluation. Paying back debt with deflated dollars may
look like a reasonable way out - but it’s a slippery slope.
A picture (or chart) is worth a thousand words.
The US is not alone. The EU is struggling with huge
differences in cultural and economic realities. On the one
hand you have the very well founded countries, like Germany,
who have carefully managed their debt and economies, now
facing the reality of having their citizens bailing out countries
like Greece who have the mindset that they are entitled to
exorbitant benefits while evading tax at every opportunity.
I think the Germans have more cause to riot in the streets than
the Greeks!
Sovereign defaults are not new. In the 1998 Russian financial
crisis, Russia defaulted on its internal debt, but did not default
on its external Eurobonds. As part of the Argentine economic
crisis in 2002, Argentina defaulted on $1 billion of debt owed
to the World Bank. These recent events stirred the market but
did not have any lasting effect of world markets.
Purchasing Power of the US Dollar from 1900
I believe that some sort of default is inevitable in Greece and
quite possibly in a couple of other EU states. To what degree
and to what effect is still debatable. The bottom line is that the
consequences of default have to be greater than the benefits.
For now it’s clear a US default isn’t really an option.
World reserve currency
The one thing that the USD has had going for it is that since
1944 when it took over from the British Pound Sterling, it has
been the world’s reserve currency, meaning that it is the most
significant holding of most governments and institutions in
their foreign exchange reserves. More importantly it also is the
international pricing currency for products traded on a global
markets such as oil, gold, etc. This permits the issuing country
to purchase the commodities at a marginally lower rate than
other nations, which must exchange their currencies with
each purchase. It also permits the government issuing the
currency to borrow money at a better rate, as there will always
be a larger market for that currency than others.
Conclusion:
The road ahead is unclear and I am
NOT convinced that governments have learnt from the
financial sector fiasco or distanced themselves from the
very players that caused it. I do know that legislators
throughout the world are hooked like heroin on deficit
financing despite the effects of devaluation and risk of
default. These factors have elevated short- to mid-term
risk . However,
ECONOMIC DATA IS LIKE A BIKINI THEY DO REVEAL A LOT,
BUT IT’S WHAT THEY DON’T REVEAL THAT IS VITAL.
Opportunities do exist in the midmid- to longlong-term and I
will follow up this newsletter in a couple of weeks with
specific strategies that you should consider.
Gary Cole Financial Services • 123 Wallace Dr Cambridge Ont N1T 1K7 • 519-621-8535 • 1-888-755-6977 • FAX 519-621-8571
The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific
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Insurance
Corporation
or by
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There can
be no assurances
that the fund will be able to
“Only Deposit
when the
tide goes
out do you
discover
who's
been
swimming
naked”.
Warren Buffett
maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you.
“For years governments have been promising more than they can deliver, and delivering more than they can afford”- Paul Martin