Sunday, December 23, 2007

Dirty Laundry

Since the 1600s, there have been five occasions when major worldwide financial crises have occurred, and they all used securitization of credit:

The 1637 Tulip-mania bubble was based on a market in tulip futures, securitized with personal credit notes.

The 1721 South Sea Bubble was securitized by shares of the South Sea company, a company operating in South America.

The 1789-1795 bankruptcy of the French monarchy was securitized by "assignats," bills of credit based on lands confiscated from the clergy.

The Panic of 1857 was securitized by railway shares.

The 1929 Wall Street crash was securitized by stock shares, and by bonds from well over 100 foreign countries. This is described in "The bubble that broke the world."

Today of course we're securitizing credit by turning subprime mortgages and other questionable credit into credit derivatives and CDOs.

We're now overdue for the next generational crash. It could happen tomorrow, next week, next month or next year, but it's coming soon.

Will we see a stagflation, a recession or a depression?

It will be an era of severe depression, worse than the 1930s, with massive unemployment, bankruptcies, homelessness and starvation.

Can something like "circuit breakers" prevent a panic?

"Circuit breakers" are used by the stock markets to try to control a panic. If the market loses, say 15% in one day, then the market closes for a few hours, to let people catch their breath.

Unfortunately, circuit breakers are useless.

A generational crash is an elemental force of nature, like a tsunami.

There will be millions or even tens of millions of Boomers and Gen-Xers in countries around the world, never having seen anything like this before, and not having believed it was even possible, suddenly in a state of total mass panic, trying to sell all at once.

Computer systems will crash or will be clogged for hours, or perhaps even for a day or two. People who had hoped to get out just as the collapse is occurring will be totally screwed, and will lose everything. Brokers and other institutions will go bankrupt. People who went short hoping to make a fortune will find that their brokers' escrow accounts are gone, and they'll be totally screwed, and will lose everything.

Being in the market today, either short or long, is a very high risk proposition.

What's a credit crunch, and what's going on?

The easiest way to understand it is this.. The world's money is disappearing. Everday there's less money in the world than the day before. Since there is less available, it's harder to get money, unless you're willing to pay high interest rates to get it. Hence, there is a "credit crunch."

One result is that banks are hoarding money, and are increasingly reluctant to lend money to one another or to other businesses. This means that even legitimate, credit-worthy individuals and companies are having a hard time getting credit, getting mortgages, or getting loans without having to pay extremely high interest rates.

How could there possibly be less money in the world?

It's not that people are eating dollar bills for lunch.

In fact, paper money is pretty irrelevant these days. Very little money is created by means of printing presses today. Money is created by means of credit. When a central bank (like the Fed or the Bank of England) wants to create more money, it doesn't run the printing presses, but simply lowers the short-term inter-bank lending rate, so that there'll be more credit, hence more money.

Unfortunately, financial institutions found that they can use a technique called "leveraging" to create money from credit, essentially going around the powers of the central bank. They create a new security and tell you that it's worth $10, but they'll let you buy it for $1 and loan you the other $9. So $10 that didn't exist before now does, a magical 'printing press' re-invented.

These securities are called "credit derivatives", and among them are CDSs (credit default swaps) and CDOs (collateralized debt obligations).

The credit bubble has created $750 Trillion in notional value credit derivatives. Are those credit derivatives the same as money? Not exactly. You can't go into the grocery store and pay for your groceries with a credit derivative.

But you CAN use those credit derivatives in your portfolio as collateral for a loan, and then you can use THAT money to buy groceries. So in fact the credit derivatives do create money.

That's what's been happening up until July of this year. But suddenly people are discovering that the security that was supposedly worth $10 is really worth only $5 or $2 or even $1, and sometimes they're totally worthless. So the process of creating money is now going in reverse. Instead of money being created through credit, today money is being destroyed through the unwinding of the credit bubble.

How much money has been destroyed since July?

A huge amount already. Let's start with an example.

Things really started moving in mid-July, when Bear Stearns announced that its hedge funds were practically worthless. That's because the hedge funds were these CDOs that had been magically created, and were supposedly worth several billion dollars. Well, they discovered that nobody wanted to buy them, and if nobody buys them, then they have no market value when they're "marked to market."

Since then a number of financial institutions have "gone to the confessional" explaining they too have lost a great deal of money in write-downs because their portfolios contained worthless CDOs. These are major financial institutions like Citigroup, Merrill Lynch, Morgan Stanley, Goldman Sachs and JPMorgan Chase.

Citibank tried to save itself by means of a fraudulent scheme known as a "Master-Liquidity Enhancement Conduit (M-LEC)." Under the scheme, Citibank and other banks would sell worthless CDOs to each other at inflated prices in order to establish a phony "market price" for the CDOs. Citibank's fraudulent M-LEC idea didn't take off, forcing the bank to take $16.4 Billion in write-offs of worthless CDOs. Citibank might have gone bankrupt except it was saved by an investment by the Abu Dhabi Investment Authority.

These big financial institutions are announcing more every day, and mainstream estimates vary as high as $500 Billion in write-downs.

So now that $500 billion is gone. That's money that existed a few months ago, but no longer exists, and that's how money gets destroyed.

And that's only the large institutions. We've hardly heard from the small institutions, but we're beginning to. State and local governments in Florida and Montana have to freeze their investment pools because the pools were found to have invested in near-worthless CDOs. And that's the tip of the iceberg. There are tens of millions more small and medium-sized institutions around the world that are going to have similar situations, forcing them to write-down these securities.

With $750 Trillion of notional credit derivatives in the world, it would not be surprising if the total write-down amounts to $7.5 Trillion (1%) or even $75 Trillion (10%).

Is that all?

Hardly. Because next you have the De-leveraging problem.

When a bank has $1 Million in assets available, it can loan out 5 or 10 times as much as that, or $5-10 Million. That's leveraging.

But if the $1 Million in assets suddenly disappears, then there's $5-10 Million that it can't loan out any more. That's De-leveraging.

The point of all this is that there's MUCH less money in the world today, and there's less and less everyday.

What do sub-prime mortgages have to do with all this?

For the most part, residential sub-prime mortgages were the original "seeds" for the credit explosion. Banks started requiring less and less from people wanting mortgages, and by the time it was over, anyone could get a mortgage for any amount, with no problems, even if they had no assets, no income, no job, and no hope of even making the mortgage payments.

These mortgage loans, like any other form of credit, created new money. That new money could then be leveraged into credit derivatives that were worth 5-10 times as much as the original mortgage loans. Those credit derivatives could then be leveraged further. This process would continue several times.

However, there were other "seeds" as well. Requirements for credit cards and other forms of credit were also relaxed, so that people could get credit that way as well. Delinquencies have been rising in credit cards, car loans, student loans, even business loans, just as they have in mortgage loans.

Why would banks make loans to people who couldn't pay them back?

Because the banks made money that way, lots of it. The loan officers made commissions from the loans. I'd be happy to lend you $1 Million of someone else's money if I got a $50,000 commission from it, and that's what happened. That's what happened with mortgage loans, with credit card loans, with car loans, with student loans, business loans, and so forth.

And then the financial geniuses got hold of the loan contracts and turned them magically into CDOs with phony notional prices. They sold those, and got even more in hefty commissions from selling them.

So basically along the way, Wall St bankers were loaning out other people's money, and taking fat commissions for themselves.

Isn't that illegal?

You're damn right it's illegal. And I can hardly wait to see some of these financial geniuses get put away.

I've been studying this stuff for awhile now, trying to figure out what's going on.

At first I thought that people were just being naïve or stupid.

But I've since come to the conclusion that the mess that we're in was done on purpose -- by contemptuous and nihilistic Gen-Xers taking advantage of air-head Boomers too dumb to work the numbers on their investment portfolios.

The point is that a lot of people have committed crimes, and they're going to well-deserved jail cells.

What's a "structured investment vehicle" (SIV)?

This is one of the gimmicks that the financial geniuses created. Their objectives were to collect huge commissions for themselves, while defrauding the general public with securities that they knew had to become almost worthless. The SIV is part of that.

When banks issue these CDOs, they aren't issued by the bank itself. Instead, the bank creates a new "virtual" bank called a "structured investment vehicle." All the "financial magic" is done within the SIV, so that if something goes wrong, the original bank had nothing to do with it. That's called "keeping structured securities off-balance sheet" of the original bank, a phrase you see often in the press.

However, the same people are involved in both the original bank and the SIV, and so they still PERSONALLY collect the same huge commissions, often in the millions of dollars.

To understand these, it helps to understand the structure of an SIV -

First an SIV has investors - like hedge funds, or wealthy individuals who invest say $1 Billion in the SIV. Then the SIV issues commercial paper (CP) and medium-term notes (MTN) that pay slightly higher rates than similar duration paper. The typical SIV according to Fitch, uses 14 times leverage, so in our example the SIV would sell CP and MTN for $14 Billion.

Now the SIV invests this $15 Billion ($1 Billion equity and $14 Billion borrowed) in longer term notes. The idea is simple: borrow short, lend long, hedge the interest rate and credit risks - and the profits flow to investors in the SIV.

What happens when the CP comes due and no one wants to buy any more? To cover the CP, the SIV might have to sell the longer term assets at a steep discount, and this would trigger a liquidation of the entire SIV. To prevent this "fire sale", the sponsoring banks stepped up and provided financing to cover the expiring CP.

And just so we know who we're talking about here: When it says "the SIV has investors like hedge funds or wealthy individuals" -- that's a little misleading. Because the investors also include ordinary people's pension funds and so forth. I don't think that the people of Florida would consider themselves "wealthy individuals," now that their investment pool contains SIV funds that must be written down.

The last paragraph above is the reason why banks have been forced to write-down SIV funds: no one wants to buy the commercial paper anymore, once the Bear Stearns hedge funds collapsed in July. And they've been desperately using every trick they could play to keep the fraud going by avoiding the "fire sale" as long as possible.

What part do rating agencies play?

The three ratings agencies -- Standard & Poor's, Moody's Investors Service and Fitch Ratings colluded with the banks to defraud the public, as Bloomberg news accused on June 30.

While the bankers were taking fat commissions for themselves, they were also making fat payments to the ratings agencies to provide AAA ratings on the CDOs in the SIVs. This was an essential part of the scheme.

Take, for example, the Florida investment pool we've been talking about. The people who ran that pool didn't know which securities were good and which were questionable. They just depended on the ratings from the rating agencies. And one of their internal rules is that the pool could invest ONLY in AAA securities.

So if the bank managers pay the ratings agencies to provide AAA ratings on the questionable securities in the SIVs, then Florida and anyone else could invest in them without even asking any questions. The bankers would get their fat commissions, the ratings agencies would get their fat fees, and the investors would be the only ones getting screwed.

And there is NO CHANCE WHATSOEVER that these agencies didn't know what they were doing.

Sure, maybe the first few deals really were OK. But as time went on, and the rules were bent more and more, there could have been NO DOUBT in the minds of these bankers and ratings agencies that they were defrauding the public.

After Bloomberg accused the ratings agencies of fraud on June 30, they knew they had to change. Since then, they've been re-rating many of the SIV securities, sometimes lowering their ratings as many as 10 or 20 levels lower than the original AAA rating. That's what happened to many of the securities that the Florida investment pool had invested in, and that's why they're currently facing a financial crisis.

Hey, who's minding the ship here anyway? Was everyone, all the way to the 'top' cashing in on this fraud?

The answers will come as this credit crunch unwinds, exposing all the dirty laundry on Wall Street, and possibly right up through the political administration in the US itself. Of this, I have no doubts!

Tuesday, December 18, 2007

A Collapsing Banking System

...Banks don't have the reserves to cover their downgraded assets and the Federal Reserve cannot simply monetize their bad bets. There's no way out...

Stocks fell sharply last week on news of accelerating inflation which will limit the Federal Reserves ability to continue cutting interest rates. On Tuesday the Dow Jones Industrials tumbled 294 points following the Fed's announcement of a quarter point cut to the Fed Funds rate. On Friday, the Dow dipped another 178 points when government figures showed consumer prices had risen 0.8 per cent last month after a 0.3 per cent gain in October. The stock market is now lurching downward into a "primary bear market". There has been a steady deterioration in retail sales, commercial real estate, and the transports. The financial industry is going through a major retrenchment, losing more than 25 per cent in aggregate capitalization since July. The real estate market is collapsing. California Gov Arnold Schwarzenegger announced on Friday that he will declare a "fiscal emergency" in January and ask for more power to deal with the $14 billion budget shortfall from the meltdown in sub-prime lending.

Economists are beginning to publicly acknowledge what many market analysts have suspected for months; the nation's economy is going into a tailspin.

Morgan Stanley's Asia Chairman, Stephen Roach, made this observation in a New York Times op-ed on Sunday:

This recession will be deeper than the shallow contraction earlier in this decade. The dot-com-led downturn was set off by a collapse in business capital spending, which at its peak in 2000 accounted for only 13 percent of the country's gross domestic product. The current recession is all about the coming capitulation of the American consumer - whose spending now accounts for a record 72 percent of GDP.

Most people have no idea how grave the present situation is or the disaster the country will face if trillions of dollars of over-leveraged bonds and equities begin to unwind. There's a widespread belief that the stewards of the system - Bernanke and Paulson - can somehow steer the economy through this "rough patch" into calm waters. But they cannot, and the presumption shows a basic misunderstanding of how markets work. The Fed has no magical powers and will not allow itself to be crushed by standing in the path of a market-avalanche. As foreclosures and bankruptcies increase, stocks will crash and the fed will step aside to safety.

In the last few weeks, Bernanke and Paulson have tried a number of strategies that have failed. Paulson concocted a plan to help the major investment banks consolidate and repackage their nonperforming mortgage-backed junk into a "Super SIV" to give them another chance to unload their bad investments on the public. The plan was nothing more than a public relations ploy which has already been abandoned by most of the key participants. Paulson's involvement is a real black eye for the Dept of the Treasury. It makes it look like he's willing to dupe investors as long as it helps his Wall Street fogeys.

Paulson also put together an "industry friendly" rate freeze that is supposed to help struggling homeowners avoid foreclosure. But the plan falls well short of providing any meaningful aid to the estimated 3.5 million homeowners who are facing the prospect of defaulting on their loans if they don't get government assistance. Recent estimates by industry experts say that Paulson's plan will only help 140,000 mortgage holders, leaving millions of others to fend for themselves. Paulson has proved over and over that he is just not up to the task of confronting an economic challenge of this magnitude head-on.

Fed chief Bernanke hasn't done much better than Paulson. His three-quarter point cut to the Fed's Funds rate hasn't lowered interest rates on mortgages, stimulated greater home sales, stabilized the stock market or helped banks deal with their massive debt-load. It's been a flop from start to finish. All it's done is weaken the dollar and trigger a wave of inflation. In fact, government figures now show energy prices are rising at 18.1 percent annually. Bernanke is apparently following Lenin's supposed injunction ­ though there's no conclusive evidence he actually said it -- that "the best way to destroy the Capitalist System is to debauch the currency."

On Wednesday, the Federal Reserve initiated a "coordinated effort" with the Bank of Canada, the Bank of England, the European Central Bank, and the Swiss National Bank to address the "elevated pressures in short-term funding of the markets." The Fed issued a statement that "it will make up to $24 billion available to the European Central Bank (ECB) and Swiss National Bank to increase the supply of dollars in Europe." (Bloomberg)

The Fed will also add as much as $40 billion, via auctions, to increase cash in the US. Bernanke is trying to loosen the knot that has tightened Libor (London Interbank Offered Rate) rates in England and reduced lending between banks. The slowdown is hobbling growth and could send the world into a recessionary spiral. Bernanke's "master plan" is little more than a cash give-away to sinking banks. It has scant chance of succeeding. The Fed is offering $.85 on the dollar for mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) that sold last week in the E*Trade liquidation for $.27 on the dollar. At the same time, the Fed has promised to keep the identities of the banks that are borrowing these emergency funds secret from the public. The Fed is conducting its business like a bookie.

Unfortunately, the Fed bailout has achieved nothing. Libor rates - which are presently at seven-year highs have not come down at all. This is causing growing concern among the leaders of the Central Banks around the world, but there's really nothing they can do about it. The banks are hoarding cash to meet their capital requirements. They are trying to compensate for the loss of value to their (mortgage-backed) assets by increasing their reserves. At the same time, the system is clogged with trillions of dollars of bad paper which has brought lending to a halt. The huge injections of liquidity from the Fed have done nothing to improve lending or lower inter-bank rates. It's been a flop. The market is driving interest rates now. If the situation persists, the stock market will crash.

Staring Into the Abyss

One of Britain's leading economists, Peter Spencer, issued a warning on Saturday:

The Government must suspend a set of key banking regulations at the heart of the current financial crisis or risk seeing the economy spiral towards a future that could make 1929 look like a walk in the park.

Spencer is right. The banks don't have the money to loan to businesses or consumers because they're trying to raise more cash to meet their capital requirements on assets that continue to be downgraded. (The Fed may pay $.85 on the dollar, but investors are unwilling to pay anything at all.) Spencer correctly assumes that the reason the banks have stopped lending is not because they "distrust" other banks, but because they are capital-strapped from all their "off balance" sheets shenanigans. If the Basel regulations aren't modified, money markets will remain frozen, GDP will shrink, and there'll be a wave of bank closings.

Spencer said:

Banks are staring into the abyss. The Financial Services Authority must go round and check that all banks are solvent, and then it should cut the Basel capital requirement level from 8pc to about 6pc. ("Call to Relax Basel Banking Rules, UK Telegraph)

Spencer confirms what we already knew; the banks are seriously under-capitalized and will come under growing pressure as hundreds of billions of dollars of mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) continue to lose value and have to be propped up with additional capital. The banks simply don't have the resources and there's going to be a day of reckoning.

Pimco's Bill Gross put it like this: "What we are witnessing is essentially the breakdown of our modern day banking system." Gross is right, but he only covers a small portion of the problem.

The economist Ludwig Von Mises is more succinct in his analysis:

There is no means of avoiding the final collapse of a boom brought on by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

The basic problem originated with the Federal Reserve when former Fed chief Alan Greenspan lowered interest rates below the rate of inflation for 31 months straight which pumped trillions of dollars of low interest credit into the financial system and ignited a speculative frenzy in real estate. Greenspan has spent a great deal of time lately trying to avoid any blame for the catastrophe he created. He is a first-rate "buck passer". In Wednesday's Wall Street Journal, Greenspan scribbled out a 1,500-word defense of his actions as head of the Federal Reserve, pointing the finger at everything from China's "low cost workforce" to "the fall of the Berlin Wall". The essay was typical Greenspan gibberish. In his trademark opaque language, Greenspan tip-toes through the well-documented facts of his tenure as Fed chief to absolve himself of any personal responsibility for the ensuing disaster.

Greenspan's apologia is a masterpiece of circuitous logic, deliberate evasion and utter denial of reality. He says:

I do not doubt that a low US federal-funds rate in response to the dot-com crash, and especially the 1 per cent rate set in mid-2003 to counter potential deflation, lowered interest rates on adjustable-rate mortgages (ARMs) and may have contributed to the rise in US home prices. In my judgment, however, the impact on demand for homes financed with ARMs was not major.

"Not major"? 3.5 million potential foreclosures, 11-month inventory backlog, plummeting home prices, an entire industry in terminal distress pulling down the global economy is not major?

But Greenspan is partially correct. The troubles in housing cannot be entirely attributed to the Fed's "cheap credit" monetary policies. They were also nursed along by a Doctrine of De-regulation which has permeated US capital markets since the Reagan era. Greenspan's views on how markets should function were -- to a great extent, shaped by this non-interventionist and non-supervisory ideology which has created enormous equity bubbles and imbalances. The former Fed chief's support for adjustable-rate mortgages (ARMs) and sub-prime lending shows that Greenspan thought of himself more as a cheerleader for the big market-players than an impartial referee whose job was to monitor reckless and unethical behavior.

Greenspan also adds this revealing bit of information in his article:

"The value of equities traded on the world's major stock exchanges has risen to more than $50 trillion, double what it was in 2002. Sharply rising home prices erupted into major housing bubbles world-wide, Japan and Germany (for differing reasons) being the only principal exceptions." ('The Roots of the Mortgage Crisis', Alan Greenspan, Wall Street Journal)

This admission proves Greenspan's culpability. If he knew that stock prices had doubled their value in just 3 years, then he also knew that equities had not risen due to increases in productivity or demand, (market forces). The only reasonable explanation for the asset inflation therefore, was monetary policy. As his own mentor, Milton Friedman famously stated, "Inflation is always and everywhere a monetary phenomenon". Any capable economist would have known that the explosion in housing and equity prices was a sign of uneven inflation. Now that the bubble has popped, inflation is spreading like mad through the entire economy.

Greenspan is a very sharp man. It is crazy to think he didn't know what was going on. This is basic economic theory. Of course he knew why stocks and housing prices were skyrocketing. He was the one who put the dominoes in motion with the help of his printing press.

But Greenspan's low interest credit is only part of the equation. The other part has to do with the way that markets have been transformed by "structured finance".

What's so destructive about structured finance is that it allows banks to create credit "out of thin air", stripping the Fed of its role as controller of the money supply. David Roach explains how this works in an excerpt from his book "New Monetarism" which appeared in the Wall Street Journal:

The reason for the exponential growth in credit, but not in broad money, was simply that banks didn't keep the loans on their books any more-and only loans on bank balance sheets get counted as money. Now, as soon as banks made a loan, they "securitized" it and moved it off their balance sheet.

There were two ways of doing this. One was to sell the securitized loan as a bond. The other was "synthetic" securitization: for example, using derivatives to get rid of the default risk (with credit default swaps) and lock in the interest rate due on the loan (with interest-rate swaps). Both forms of securitization meant that the lending bank was free to make new loans without using up any of its lending capacity once its existing loans had been "securitized."

So, to re-define liquidity under what I call New Monetarism, one must add, to the traditional definition of broad money, all the credit being created and moved off bank balance sheets and onto the balance sheets of non-bank financial intermediaries. This new form of liquidity changed the very nature of the credit beast. What now determined credit growth was risk appetite: the readiness of companies and individuals to run their businesses with higher levels of debt. (Wall Street Journal)

The banks have been creating trillions of dollars of credit (by originating mortgage-backed securities, collateralized debt obligations and asset-backed commercial paper) without maintaining the proportional capital reserves to back them up. That explains why the banks were so eager to provide mortgages to millions of loan applicants who had no documentation, no income, no collateral and a bad credit history. They believed there was no risk, because they were making enormous profits without tying up any of their capital. It was, quite literally, money for nothing.

But now the mechanism for generating new loans (and fees) has broken down. The main sources of bank revenue have either been seriously curtailed or dried up entirely. Mortgage-backed Commercial Paper (MBCP) one such source of revenue, has decreased by a full-third (or $400 billion) in just 17 weeks. Also, the securitization of mortgage-backed securities is DOA. The market for MBSs and CDOs and other complex bonds has followed the Pterodactyl into the history books. The same is true of structured investment vehicles (SIVs) and other "off balance-sheet" swindles which have either gone under entirely or are presently withering with every savage downgrade in mortgage-backed bonds. The mighty juggernaut that was grinding out the hefty profits (structured investments) has suddenly reversed, and is crushing everything in its path.

The banks don't have the reserves to cover their downgraded assets and the Federal Reserve cannot simply "monetize" their bad bets. There's no way out. There are bound to be bankruptcies and bank runs. "Structured finance" has usurped the Fed's authority to create new credit and handed it over to the banks.

Now everyone will pay the price.

Investors have lost their appetite for risk and are steering clear of anything connected with real estate or mortgage-backed bonds. That means an estimated $3 trillion of securitized debt (CDOs, MBSs and MBCP) will come crashing to earth delivering a violent blow to the economy.

It's not just the banks that will take a beating. As Professor Nouriel Roubini points out, the broker dealers, investment banks, money market funds, hedge funds and mortgage lenders are in the cross-hairs as well.

Non-bank institutions do not have direct access to the Fed and other central banks for liquidity support, and so are now at risk of a liquidity run as their liabilities are short term while many of their assets are longer term and illiquid; so the risk of something equivalent to a bank run for non-bank financial institutions is now rising. And there is no chance that depository institutions will re-lend to these non-banks the funds borrowed by central banks as these banks have severe liquidity problems themselves and do not trust their non-bank counter-parties. So now monetary policy is totally impotent in dealing with liquidity problems and the risks of runs on liquid liabilities of a large fraction of the financial system. (Nouriel Roubini's Global EconoMonitor)

As the downgrades on CDOs and MBSs continue to accelerate, there'll likely be a frantic "flight to cash" by investors, just like the recent surge into US Treasuries. This could well be followed by a series of spectacular bank and non-bank defaults. The trillions of dollars of "virtual capital" that were miraculously created through securitzation when the market was buoyed-along by optimism will vanish in a flash when the market is driven by fear. In fact, the equity bubble has already been punctured, so the process is well underway.