Monday, August 15, 2011

“The Sequel”: How 2011 Is A Repeat of 2008—Only Bigger, Longer, and Uncut by Bailouts

I might have missed it, but I don’t think anyone has noticed this simple truism:

The structural causes that led to the Global Financial Crisis of 2008 are identical to the structural causes that are leading us to another systemic financial crisis in 2011.

You saw this one already?
The only difference is the kind of debt at the core of the looming crisis: Mortgage-backed securities in 2008, as opposed to European sovereign debt in 2011.

And of course, the debt hole in 2011 is bigger than in 2008—a lot bigger.

That’s why I am confident in predicting we are about to have another Global Financial Crisis—I’m calling it The Sequel: Same movie, same players, same story. Only this time around—like all good sequels—the financial crisis we are about to experience is going to be bigger, longer, and uncut by bailouts.

By the way, that is the key difference between 2008 and 2011: We’re not going to have a Hollywood Ending this time around. The governments of Europe and the United States, as well as their respective central banks, do not have any weapons to fight off this 2011 financial crisis, as they did in 2008, for the simple reason that they used them all up—they’re out of bullets, both monetarily and politically.

So when The Sequel hits the big screen, there won’t be a Big Daddy Government deus ex machina to come save the day in the third act twist. When The Sequel hits, we’re on our own.

Let’s discuss the structural similarities between the original and The Sequel:

In both 2008 and now 2011, you had unpayable debts at the center of a fragile financial system. In 2008, it was mortgage backed securities and collateralized debt obligations—the so-called “toxic assets”. I think we all know that story pretty well.

In 2011, we have European sovereign debt. And just like the toxic assets of 2008, the Euro-bonds might have been rated AAA, but they certainly aren’t blue-chip—they are more like brown-chip: That deep brown color peculiar to fast-sinking dog-turds.

In both 2008 and 2011, these unpayable debts—emitted over many years, accumulating silently and asymptomatically like plaque in the arteries—gave a false sense of prosperity in the years leading up to the respective crises.

In the lead up to 2008, the MBS’s and CDO’s gave the American homeowner a sense that their house was their personal private ATM sitting on their quarter-acre suburban lot. They also were a profit spigot for the financial sector, which bouyed the U.S. GDP growth, leading to a false sense of national prosperity, even as there were signs that the non-financial sector of the economy was diving.

In the lead up to 2011, on the other hand, the sovereign debt of the eurozone countries gave the European citizens a sense that they could afford to buy all the imported goods they could ever want, as well as the sense that their government could afford to pay for all the social welfare programs they were all promised—without having to pay for any of this by way of higher taxes. Hell, that was the entire Labour governments’ platform between 1997 and 2010: Blair and Brown gave the UK a welfare state and low taxes—all paid for with sovereign debt.

In both 2008 and 2011, you have banks exposed to these bad debts both directly and indirectly—and this exposure in 2011 threatens to topple the entire financial structure, just as it almost did in 2008.

In 2008, the financial institutions with direct exposure to the toxic assets—that is, the institutions that actually owned these crap bonds that would never be paid in full—were mostly American banks. Their capitalization depended on how pristine these toxic assets were. As it became increasingly clear that the toxic assets were exactly that—toxic—the banks holding this crap found themselves not only without the capitalization to pass regulatory muster, but in fact found themselves functionally insolvent—hence the suspension of FASB 157, coupled with the injection of $150 billion worth of capital by way of TARP.

In 2011, the financial institutions with direct exposure to toxic assets—in this case, the European sovereign bonds, especially from the PIIGS—are once again banks, this time around mostly European banks: UniCredit, Société Générale, Dexia.

Like 2008, these assets might be rated triple-A, but they’re dog-turds—and they threaten these banks with insolvency, if any of them default. A bankruptcy of any of the aforementioned European banks would have massive consequences for the rest of the global financial construct—it would not be a Europe-only problem, just as the bankruptcy of Lehman was most definitely not an America-only catastrophe.

And that’s just the direct exposure to the 2011 version of toxic assets.

The real danger in 2011 is the indirect exposure—that is, the liabilities that are triggered in the case of a debt default: Just like 2008.

In 2008, it was AIG and other assorted credit default swap sellers that got hit bad, when the toxic assets began to default—we all remember how the very ground we trod rocked as AIG stumbled and everybody had a collective nuclear-meltdown freak-out.

In 2011—you guessed it—it’s worse: We have Bank of America for sure has massive exposure to derivatives on European sovereign and debt, as well as . . . God Knows who else.

Why do I say “God Knows who else”? Because just like in 2008, the derivatives market is so opaque—not to say hermetic—that we are not going to know who’s going to go bust until it actually happens. In 2008, Hank Paulson and the Treasury Department didn’t find out about the AIG hole until the weekend before the company would go bust. Today, in 2011—even with the experience of how potentially deadly ignorance of the derivatives markets can be—there are no mechanisms in place to swiftly and accurately tally who has derivatives exposure to any particular bond or asset.

In other words, Tiny Timmy and Bailout Benny never implemented the one lesson learned from 2008: Make the markets transparent, so that you can see where the crisis is coming from before it falls on top of your head.

Thus they—and we collectively—are flying blind insofar as derivatives written on the European sovereign debt. We only know about BofA’s massive CDS exposure indirectly, through Timothy Geithner’s demand in December 2010 that Ireland not default, because of the massive losses an Irish sovereign default on BofA.

Bernanke and Geithner had the chance to regulate this vital piece of the financial markets—but they didn’t! Instead, they acquiesced to this ridiculous pseudo-“ideology” that we should not regulate the financial markets.

(Parenthetically, and speaking as a hard-core, anti-choice, anti-vegan, pro-gun, pro-red meat Conservative: I am sick and tired of the ignorant assholes who say, “All government regulation is bad! Let the free markets reign!” We have the government regulate various industries and products because it is necessary for our individual and collective safety—or would you rather the government never regulated, say, the water supply, car safety standards, housing standards? Would you prefer it if the FDIC ceased to exist, and your local S&L could go to Vegas and play the roulette wheel with your life savings? Certainly not. Not only do we need government regulation for safety standards, we need regulations to prevent unscrupulous exploiters from gaming the system—think Enron, which should have put paid to any ridiculous notion that “the market knows best”, but obviously hasn’t (or else I wouldn’t be ranting here): The Enronites of the “energy trading desks” exploited the free markets and the lack of government regulation in the so-called “energy markets”, and deliberately created rolling blackouts in California so as to gouge the people of that state for the electricity they already owned and which they should have been getting, but which the Enron bastards were manipulating in order to squeeze them for money. Insofar as the financial markets are concerned, anyone spouting that particular bullshit spiel about the markets knowing best is either a shill for the banks, or a complete and utter imbecile. And a bank shill at least has the excuse of needing to pay the mortgage in exchange for spouting this nonsensical bullshit—the imbecile does not.)

Now, I used to write for the movies—I can tell you the secret to writing a good sequel: Use the exact same elements, the exact same story structure—hell, even use the exact same lines!—but make sure the sequel is bigger: Bigger sets, bigger explosions, bigger stars, bigger everything—a bigger bang for the buck.

2011’s The Sequel is certainly going to deliver that bigger bang—because it’s a lot bigger than 2008: The total sovereign debt of the PIIGS is about €3.1 trillion. That’s 20% of the eurozone’s GDP—just the PIIGS, just those five, forget about France, Belgium and the UK, which if added up easily doubles that €3.1 trillion figure.

Compare that to 2008, when the total toxic assets the Federal Reserve wound up having to buy amounted to about $1.5 trillion—about 11.5% of the U.S.’s 2008 GDP.

In other words, the current situation is over twice what 2008 was—and might wind up being four times the 2008 price tag. And that’s just the nominal value of the toxic debt at the core of the current situation. We have no idea what the total value of the indirect exposure via derivatives is going to add up to.

So! We’ve seen that we’re structurally at the same place we were in 2008: Unpayable debts held by a fragile financial sector, with massive indirect exposure by way of derivatives that no one has bothered to tally up and regulate.

We have furthermore seen that—like all good sequels—2011 is going to have a bigger bang: We currently have more debts on deck than in 2008, at least twice as much, as a matter of fact.

Question: Why does teasing out these similarities matter?

Answer: Because it will allow us to see what will happen over the months of September and October, when the crisis breaks.

What we’ve seen over the last couple of weeks is not the crisis—or not the crisis, at any rate. We’ve seen Italian and Spanish debt drop, their yields spiking—we’ve seen gold run up to $1,820—we’ve seen the biggest drops in the US equities markets since 2008—

—but these gyrations are not The Sequel. Rather, these last couple of weeks of market gyrations have been the forewarnings—the pre-tremors. Anyone who’s lived in earthquake country knows about them: The little tremors and hiccoughs that precede The Big One.

The Sequel will actually get going once we have our Lehman-like event.

In 2008, the bankruptcy of Lehman Brothers triggered the crash—but it was not the cause of the Global Financial Crisis of 2008: The structural weaknesses were already baked into the situation—the Lehman bankruptcy was just the shove the global financial system needed to fall off the proverbial cliff.

Today, we are waiting for the Lehman-like event. My personal guess is Dexia will be the first to go under, the Lehman-like event that will trigger The Sequel—but that’s just a guess. More likely than not, the Lehman-like event of 2011 will catch us all by surprise—but just like the Lehman bankruptcy, it won’t matter intrinsically: It’ll only matter insofar as it triggers the cascade of panic-default-bankruptcies, etc.

Be that as it may, at my paid site, The Strategic Planning Group, we’ve been discussing what to do, when The Sequel hits. I won’t bother recapitulating what I’ve written there—frankly, it’s too long, and besides, the details are why the SPG Members pay their dues.

The one issue I will discuss here is the notion of a safe haven:

In 2008, when all the stock markets were going south, and all the name-brand banks were teetering, where did everyone park their money? What was the safe haven?

Treasury bonds. In fact, the flight to safety was so massive that Treasuries reached negative yields, when you factored for inflation.

Treasuries are the traditional American safe haven. But what with the recent spate of, er, questionable events (Debt celing conniption fit, anyone?), Treasuries aren’t looking as safe as they used to, nevermind the (cosmetic) S&P downgrade of their Treasuries rating.

But this isn’t an American crisis—this is a European crisis that will have catastrophic consequences in America—but the epicenter will be Europe.

What’s the safe haven in Europe? Gold.

In fact, in Europe, sovereign bonds have never been considered a “safe haven”, for the simple reason that sovereign debt in Europe has countless times suffered haircuts, defaults, outright national bankruptcies.

Since this will be a European sovereign debt crisis that will spread around the globe—but the epicenter of which will of course be in Europe—bankers and asset managers will pull their cash—euros—out of whatever they think is risky, and park it in some safe haven.

These European money men obviously cannot sell their assets and buy US Treasury bonds with those euros that they get. And they certainly won’t plug those euros into European sovereign debt, which is exactly the source of the panic. They won’t even park those euros in German bunds, for fear of contagion.

Therefore, it is reasonable to infer that, if and when there is a Lehman-like event in Europe that triggers The Sequel, the flight to safety will be to gold, which Europeans traditionally see as a financial refuge as surely as Americans consider Treasuries their financial refuge.

Hence in my estimation, gold will rocket on. I would not be surprised if gold crosses $2,000 an ounce when the Lehman-like event happens, and goes on quickly to $2,500 before the end of the year. On my scale of augury, this is head-and-shoulders above a Strong Hunch, just shy of a Fearless Prediction: $2,500 by the New Year’s. After that?

. . .

On next Wednesday’s post, I will discuss why the U.S. and European governments’ and central banks’ responses are severely curtailed and constrained, compared to 2008—and thus I will explain why we cannot expect the governments to save the day, as they did in 2008.

If you are interested, be sure to check out my Strategic Planning Group—here is the preview page. —GL


  1. Do you think hyperinflation will hit soon (12-18 months)? Flight to gold, vice Treasuries seems like a large loss of confidence in the good ole American Way. Especially in light of the awful economic data coming out recently.

    C deK

  2. So, anyone who joined SPG willing to comment on their experience with it? Is it sporadic like this? Is it worthwhile? I feel like if I'm paying I would need information close to every day. Can anyone comment on this?

  3. OT: Good to see the bullring wallpaper back. I always liked that one best.

  4. It's quality of info, not quantity, that counts. If you want mediocre daily stuff, go elsewhere. Granted, GL writes on an irregular cycle. What he does write is for the most part right on and enjoyable to read. It is actionable intelligence, but in a strategic rather than in a tactical sense.

  5. @Anonymous

    I've been an SPG subscriber since the doors opened. You are not going to get an everyday release from GL if that is what you are looking for. Instead, the value is the advanced timing of what is released. For example, a lot of what this blog covers today was developed in a scenario released on June 17th (When the Eruo breaks). You can wait and get similar information as/after an event occurs or be thinking and planning strategically weeks or months in advance. The current scenario in SPG is what you will be reading about on this blog at some point in the future, but you will have lost the benefit of the advanced analysis and planning opportunities prior to the events occurring.

    Additionally, there is the input and discussion from the SPG community without the time wasting trolling you might find on the public blog. Throw in the members only conference calls and presentations and you have a package that is well worth the monthly subscription fee.

    The easiest thing for you to do is to join for a month or two and if you don't like it, cancel the subscription. The risk is so low, it's effectively the cost of a nice meal. Decide for yourself or just read about events here as they happen and panic with everyone else.

  6. That hyperinflation hasn't come and it will not too. There is a massive flight going on into US T-bonds, similar to Japan since many years. See the record low yields. That is against all the doomers' expectations. In times of deflation, people flock together where risk is minimal and profits are not a major concern. Besides, a new banking crisis will not hit quickly, as the ECB will simply put on the printers and hand over the new liquidity. Look at the Italian and Spanish bonds. It's no solution, but the markets will calm for a while. So I look forward to Christmas time, after a nice autumn with hard working and many walks in the beautyful parks and woods. No panic here.

  7. Dear Gonzalo:

    The people at Leap/e2020 have predicted a similar outcome for the September/October time frame. Are you familiar with their work?


  8. I'm beginning to understand that simply issuing an E-Bond is'nt so simple.. it could involve parliamentary votes, referendums, negotiations, court challenges, and for all who should agree, a disturbing loss of sovereignty. The problem with this is that such a venture requires time. In a crisis, the markets want an answer NOW. TODAY. The only time E-bonds come to the forefront is in the midst of a crisis.. forethought and planning to implement such a plan seem to be lacking up to this point.

    IMHO, Europe's financial system is having a series of mini strokes: first the Greek crisis of last year, then Ireland, then Portugal, and this month comes Italy. Yet the E-Bond has not been introduced in any Parliament. At some point in the near future, Italy and Spain will become unable to hold up their end of the EFSF. Even France looked a little shaky last week. When the number of countries needing a bailout exceeds the number of countries doing the bailing, the markets will demand an answer TODAY. It's at this point that---

    1. The French and Germans either can begin a bailout so big it would likely threaten France's solvency, or..

    2. The ECB {with an assist from The Fed, the PBoC and with Germany's backing} vastly expands the SMP and begins purchasing failing sovereign bonds and bank stock, and waive the rule on "sterilization".. this is flat out monetization, and since The Fed and PBoC also participate, the Euro does'nt crash too badly in relation to most other fiat currencies... with the Swissy and Yen soaring. Germany, who has been resisting this, finally agrees when faced with financial Armageddon. As the Yen appreciates, Japan is strangled by deflation and a new phase begins.

    3. Germany and it's Nordic cousins bolt the Euro.

    My bet--- The Catastrophe behind Door #2

  9. @ Mr. Kowalski

    The Bank of Japan would therefore participate in this setup, by buying euros and dumping fresh yens.

  10. >>I would not be surprised if gold crosses $2,000 an ounce when the Lehman-like event happens...<<

    Considering that it just hit $1,800, why would it need to wait for a Lehmen-like event?

  11. @ Anonymous on Aug. 15, 11:10 am.

    Hawk5999 did a good job at explaining SPG. I would add, the extra stuff. Basicially, SPG, makes specific promises (new topic frequency, topic choices, opportunity to ask questions, etc). However, so far, SPG delivers far beyond what is advertised. I guess it is one of those uncommon diamonds - delivering more than promised.

    I would recommend it. Additionally, there are some members that I would describe as part of the fringe benefits. In my opinion, SPG is becoming a gathering place for great minds.

  12. Kansas is back again - just finished the 1:39 AM comment.

    I just thought of one drawback to SPG - you don't get the cool pics like at the top of this article. GL is especially keen in selecting his graphics. I enjoy the match ups - always done well.

    Plus, with membership there is Fred! - All SPG members get properly introduced to Fred. (Smiles big time from Kansas).

    BTW, Fred is the Black Swan you see with SPG info.

    Go back and read what Hawk5999 offered. He spoke best.

  13. @ Mr. Kowalski

    "IMHO, Europe's financial system is having a series of mini strokes..." ---Well Said!

  14. The North American Union is almost complete
    They will not bother to even tell you when it is.
    you will notice however Canadian laws governing;
    private property ,waterways,hate crimes ,gun laws
    among others.While America becomes filled with the third world peasantry you can always move to Canada if you have the cash .
    This is the future, for the empire needs soldiers not smart thinkers ,for USA is the Military end of the Triangle.

  15. The observations about regulation are correct, every society needs some but the trick is to have as few as possible and let the markets work. For that, you transparency and understanding by the buyers.

    In the financial sector, if there were no FDIC but banks were required to make full disclosure as to how they handled depositor assets, banks could and would be rated like insurance companies. Without the government FDIC guarantee, people would be a lot more careful where they put their money just like they are with stocks and bonds. You would get more responsible banking because otherwise, the bank would not get deposits.

  16. Interesting theory, and it fits with the current theme of Euro woes = gold price increase.

    However, in 2008 world stock markets imploded taking gold along with it. If Europeans never view sovereign debt as a safe haven, just where did all that money go?

    There's a reason USTs have been skyrocketing along with gold and the Swiss Franc. All are being treated as "risk off" right now. So to say gold will skyrocket without these other assets following suit makes no sense.

  17. “The Sequel”: How 2011 Is A Repeat of 2008

    Interesting that you should say that. From what I've been reading -- and if this is true -- something should trigger the financial collapse within the next 18 days, that is between Aug 18th and Sept 4th (5th Night of 9th tier of the Mayan calendar).

    According to the Mayan calendar these collapses of the old order always become manifest in what as known as the Fifth Night. (See Carl Calleman's work.)

    The last time the 5th Night occurred (8th tier) was between Nov 2007 and Nov 2008. If you check out a graph of the Dow from that time you can see the economic crash fits neatly into that time period. In Calleman's 2003 book, The Mayan calendar and transformation of consciousness, he predicted: "Regardless of what forms such a collapse may take it seems that the best bet is for it to occur close to the time that the Fifth Night begins, in November 2007."

    During the 5th Night of the 7th tier people experienced the depression and WW2, while the tier below that brought the dark ages. (Each 'day' or 'night' is longer by a factor of 20 the lower down the 9-tier pyramid you go.) It may sound like gloom and doom but each fifth night is supposed to clear the way for a better world (evolution) and on the positive side this one will be much shorter.

    You can take the above with a grain of salt but I've stuck the 8/18 - 9/4 date up just for the record. If anyone's interested there is a video up on google video called 'the mayan calendar comes north' by Ian Lungold who explains how it works. It has nothing to do with the Dec 21, 2012 hype, btw.

  18. The coming financial crisis will dwarf the last one in 2008. Deflation is the name of the game as austerity measures hit the United States and all of Europe. It is obvious that we are in recession, or actually, may never have come out of it. The only question now is, if we sink into a full blown depression. Nothing has changed since the last crisis. Let's just hope this one forces our government's hand and we actually try to fix things.

    Real estate in particular will be hit hard as incomes, loan qualification and foreclosures cause tremendous pain.

  19. How about protecting ourselves, we the middle class and the poor, instead of waiting things to happen to us:

  20. I've already heard all this "stuff" before.If the euro fails and I believe it will, wouldn't that be "good" for the dollar? GL has been screaming hyperinflation for years now.Where is it?

  21. I could make a good case for eliminating FDIC. Same reason we don't offer a flat rate for everyone's car insurance. If your rates never went up when you got a ticket or an accident, then everyone would drive reckless. FDIC encourages this same type of behavior in banks.


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