The United States Has Been Living a Lie

The United States has been living a lie.

As a nation, we have been kidding ourselves, repeating myths, hoping that if we say something enough times, it will become reality — no matter how untrue. The credit crisis and now foreclosure debacle has revealed to anyone who cares to look what we have sought to ignore: That the past decade has been based on a set of fundamental beliefs that are intrinsically false.

Its time for an intervention. We need someone to force us to stop hitting the bottle, lose the bimbo, skip the dessert cart, visit the gym. Its time to stop bullshitting ourselves about Financial Engineering, and face both the Truth & Consequences of our legacy financial system.

It is past time we recognize these hard truths:

1) There is no free lunch: The very first rule of economics has been forgotten time and again. Everything has a cost, and that cost is commensurate with value received. This includes making loans to unqualified borrowers to propping up home prices. Banks, regulators and policy makers have to start thinking in terms of collateral costs of free lunches to unintended consequences.

2) Financial Engineering is Not Alchemy: Just as you cannot convert lead to gold, neither can you convert high risk to low risk through a wave save of the spreadsheet. Ongoing attempts at eliminating risk — repackaging, syndicating and securitizing it — have been revealed as misleading nonsense. The risk involved in any directional bet cannot be removed by slicing and dicing and merely selling off various tranches. During crises, all asset classes seem to correlate anyway.

Whether its Greek bonds or Alabama’s sewer financing, changing numbers on a spreadsheet does not magically transform losses into gains, change debt to income ratios, or create wealth. All this does is temporarily mask the actual underlying financial condition of the engineered entity. Merely moving pieces of paper around has time and again been revealed as a scam; why people fall for it over and over reveals a collective failure of memory.

3) Bank Hedging Undermines Lending: At one point in time, banks’ had a collective expertise in evaluating the credit worthiness of borrowers. Whether it was revolving credit, auto loans, mortgages, or small business loans — they knew how to evaluate the likelihood of repayment or default.

In a mad grab for market share and profits, the larger lending institutions experimented with replacing their own experience and business judgment with complex hedging models.

Thus, credit risk of any borrower became far less significant, since it was to be hedged. As the financial sector became less dependent upon their own decision making, credit quality slid towards worthless. Hedging removed the banks’ incentive to quality-of-loans, and replaced it with the motivation of quantity-of-loans. Sliding all the way down the quality scale in credit ALWAYS end badly.

4) The Rule of Law is Sacrosanct: Our system of private property has developed due to the rule of law. The ability to demonstrate ownership, pass clear title, resolve disputes has worked for 100s of years. The recent frauds we have seen from law firms, process servers, bank legal departments, even drive through RE courts has put the nation at risk of becoming a lawless banana republic.

There is only one solution to this threat: For the rule of law to be in force, those people who violate it — previously known as “criminals” — must suffer the painful consequence of their illegal actions.

If you falsified documents that where used in foreclosures, you must be prosecuted for criminal fraud. If your firm’s primary purpose was this illegal activity, it must be put down. This means loss of professional licenses, corporate death penalties and jail time for offender . There is no deterrent to criminality of there are no significant penalties.

5) Campaign Finance Reform: The hijacking of the American financial system was done legally. Over the past 3 decades, the regulatory apparatus was Jiu Jitsued so that rules were made for the benefit of the financial sector — not the public. Thanks to a series of Supreme Court decisions, the corporate takeover of first Congress, then the election process, is now complete.

The only way to reverse this is a national campaign to pass a Campaign Finance reform law — preferably, a Constitutional Amendment — that gets the dirty money out of politics. Full disclosure of all donors, no hidden  advantages for corporate cash, public financing of Congressional elections needs to be written into the constitution.

No one likes to face the hard ugly truths about themselves. As a nation, we need an intervention — our closest friends need to sit us down and slap us across the face. The sooner we stop kidding ourselves, the sooner we can move forward with more productive honest economic lives . . .

Barry, I sometimes conclude you are a bit too status quo-y for me. Not this time.

Well done.

Now, who’s gonna lead us?

[...] Some ugly truths about ourselves and the destruction our financial engineering has wrought.  (TBP) [...]

BR:

I'd reorder your list, by priority, as follows:

4, 5, 3, 2, 1

No, 4 is the drum I beat (constantly). If we take care of No, 4, fixing everything else will be much easier.

Bravo!

The NYT and WSJ should run this (with appropriate attribution and payment, of course) on their front pages.

The Congress should be continuously water-boarded whilst having this read to them until it takes hold.

But I suspect that more than a few of them would expire before getting the message. I suppose one would call that “A Good Start”.

“our closest friends need to sit us down and slap us across the face” Hehe, we would love to do that! But, come on, who dares to slap a superpower?

For the rule of law to remain in force, those people who violate it "” previously known as "criminals" "” must suffer the consequence of their illegal actions.

Yes, but how high up the food chain are you willing to go? Just high enough to eliminate the competition from the more well connected boys? Or maybe a little higher. How about prosecuting some for treason against their nation, failing to uphold the constitution, putting the nation in a financial and military situation that jeopardizes the nation’s security and even fails to protect it own citizens from foreign invaders?

Do you want to start at the bottom and work your way up or how about starting at the top and working your way down? Maybe when you remove the glass ceiling the fleas will learn to jump a little higher

Every Now & Then, BR grabs the wheel of his own blog and spits out heartfelt opinions. This blogger is left thunderstruck by the clarity of today’s post. Not once did he mention that Capitalism without failure is like religion without sin. That’s what readers are for.

Will the rule of law be abandoned ?

Answer: not if BR has his way!

Amen, Barry, amen.

nice post, BR..

as well, http://www.bloomberg.com/news/2010-10-08/taleb-says-crisis-makes-nobel-panel-liable-for-legitimizing-economists.html

in general..

and, http://www.tenthamendmentcenter.com/2010/09/08/with-or-without-federal-permission/

more specifically, lest we forget that the ‘Banks’, just this Century, were handed a huge assist when ‘Federal Preemption’ p*mp-slapped the State AGs that were trying to rein in the Abusers of their Citizens..

“Defund to Defend”

I woukd start at the top and work down

I’m with you. ! The only chance I see, for progress on these "real" issues is if another politcal party is formed ,that in turn could help realign one of them to be practical,pragmatic about our future ! And , of course I don’t see tea party as the pragmatic, practical one, but, we can only hope they may help (creative destruction) the others to drink,own and prescribe the truth about our problems ! ( You. See it in local nyc politics, major parties , rather lose to the other major party , than lose to a alternative one .)

right on, BR…

At least America’s Team is starting to resemble America – or is it the other way round?

1)No Free Lunch: The Fed recently announced that their policy is to prop up asset prices.

2)Financial Engineering Alchemy: Mark to Market Accounting for banks was eliminated precisely to mask bank losses,everything will be fine until they’re insolvent and need another bailout. They need a crisis to justify the next raid on taxpayers money. Stress tests were another regulatory mask, Fed defiance of FOIL laws etc.

3)Bank Hedging Undermines lending. I see a bigger problem of bank competence. Banks chased fast & easy money into areas where they had no expertise (GM and Merrill Lynch mortgages etc). Endemic documentation deficiencies of this activity are just coming to the fore. There is a basic problem of bank incompetence – trying to be all things to all people.

4)The Rule of Law is Sacrosanct. We came within a heartbeat of turning real estate law on it’s head by rewriting the notarization laws to facilitate systemic fraud by the banks to cure their paperwork failures. Sins of commission to cover up sins of omission. More broadly fraud is something that can only be committed by an individual never a corporation or corporate officer, the former is a crime the latter is an error. If an individual renegs on a 300K mortgage thats a moral failure that imperils western civilization and they should be ruined for life, if a corporation defaults on a $3 billion commercial financing thats a tough but fair business decision.

5) Campaign Finance Reform. Laws were written to legalize bribery of our politicians. We need the consent of those bribing the politicians to change these laws and I can’t see how that can be done. We can see the power of special interest with the ram-rodding of the misleadingly titled 2 page actuary law thru the Senate.