Reasons why you should never believe anything a bankster says:
On August 1st, 2007, Baudouin Prot, the CEO of French bank BNP Paribas said:
“As far as the U.S. subprime crisis is concerned, BNP Paribas’s exposure is absolutely negligible”
On August 9th, 2007, BNP Paribas suspended trading in three investment funds worth €1.6bn because of a “complete evaporation of liquidity in certain market segments of the U.S. securitization market”, meaning that they couldn’t calculate the net asset value of the funds… in other words, they may as well be worthless for all they know. For the time being at least, the funds are worthless to their investors who can’t take anything out of the funds.
That’s a pretty good reason… no doubt there are plenty of others, such as the historical quote from Arthur Reynolds, the Chairman of Continental Illinois Bank of Chicago, who said on October 24, 1929: “This crash is not going to have much effect on business.”, or the IMF’s Financial Market Update on July 25 which said “Delinquencies, defaults, and foreclosures have continued rising, especially in the 2006 vintages of subprime lending… However, so far, our assessment is that this risk is likely to remain largely contained…”, which was echoed by US Treasury Secretary Henry Paulson on July 26th. On May 17th, Fed Chairman Ben Bernanke said “…we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market…”.
The “absolutely negligible” exposure caused more than £29bn ($58bn) to be wiped off the value of companies in the UK’s FTSE-100 index, €6 billion ($8.2bn) off Irish shares, and similar things have been happening in many other markets worldwide.
How much is a $1bn? As Chan Akya of the Asia Times explained, if you actually burnt one US$100 bill every 10 seconds, it would take more than three years to get through a billion dollars.
Globalisation has led to lousy “fog a mirror and you can get a loan” mortgage debt created in the US being repackaged as “collaterised debt obligations”, or CDOs, which have been sold off around the world.
Some idiots seem to think that it’s a good thing that no single financial instution is going to be destroyed, because the crap has been distributed far and wide.
But what we have now is a situation where every financial instution is under suspicion and no-one knows exactly how much crap is being held, no-one knows how much it’s worth because the potential buyers have vanished, and what we therefore have is a global financial crisis, where even perfectly healthy banks and funds can be destroyed by rumours and spooked investors rushing to take their money out. This could easily develop into a self-fulfilling prophecy effect of people fleeing anything that might have a “negligible exposure” to subprime and looking for safe havens. Unfortunately, even funds generally accepted as safe, such as money market funds, usually thought of as equivalent to cash, are now under suspicion, as pointed out by the Wall Street Journal (August 11, 2007):
“Commercial paper, a staple investment for money-market mutual funds, are short-term loans typically issued by highly rated companies for less than a year. The market — $2 trillion in the U.S. and nearly $1 trillion in Europe — is considered one of the most easily traded and safest corners of the financial markets outside of U.S. government bonds.
But interest rates on commercial paper have risen as far and as fast as they did after the shock of the Sept. 11, 2001, terror attacks.“
And here’s another example showing how supposedly “safe” investments have been tainted by the subprime crisis:
The failure of some companies to pay on time has cast a pall over the securities, which are considered to be almost risk free, said Lee Epstein, chief executive officer of Money Market One.
“The subprime tsunami has come to the beach, as it were, to the safest of the safe,” Epstein said
Subprime `Tsunami’ Hits Asset-Backed Commercial Paper Market
The big problem with all these fancy funds is that they have linkages to other funds and borrowers at the end of a long chain who are the ultimate source of payment, and who have been vanishing in little puffs of smoke as they turn out not to be reliable sources of repayments for home loans, obtained on “fogging a mirror”, also known as “liar loans”.
Paper investments are built on top of other paper, and derivatives are built on top of them… a lot of it is interconnected, opaque and incomprehensible to mere mortals. As I explained on Goldblogger.net in October 2006, it is like a huge inverted pyramid with the only real safe investment, gold, at the bottom. Gold is safe because it has its own value… an ounce of gold is precisely that; it was worth something to ancient Romans and it will be worth something to our distant descendants.
This pyramid illustrates the relative values of each listed asset class, from the lowest risk (gold) at the bottom, to the most esoteric and least understood at the top. The volume (and area, since each layer is of the same thickness) of each layer is proportional to the total value in each asset class. For 2006 these values were in the region of:
Gold: 0.157 $ Trillion
Currency: 0.747 $ Trillion
Public Debt: 8.54 $ Trillion
M3b (minus currency): 10.1 $ Trillion
Credit market debt: 42.7 $ Trillion
Stocks and bonds: 65 $ Trillion
Derivatives (US banks): 119 $ Trillion
The figures are from the US, but most of the world is following the same fiat money path. Mostly, this system simmers away with a moderate inflation and loss of wealth that doesn’t get noticed by the majority of people. Exceptions are normally on the negative side, i.e. where the system has broken down, currencies are devaluing rapidly and people are denied access to money they thought they had in the bank.
At the base of this pyramid is gold (and/or perhaps silver). That stuff represents intrinsic value, as it is not dependent on any debt, currency or banking system for its wealth… no strings are attached.
This viewpoint was first offered by John Exter in the 1970s to represent the financial system as an inverted pyramid of debt built on a “tiny point of gold”.
Anything else is “money” created out of thin air – by fiat decree, as nowhere today is there a money system based on a gold standard in which currency is redeemable on demand in a fixed weight of precious metal. What about cash? It’s subject to currency risk… look at what happened in Argentina. Dollar, euro, pound, yen, strong resilient currencies? A dollar put aside in 1913 is worth 5 cents today. Alan Greenspan once described the bleeding of wealth through insidious currency devaluation in an essay called “Gold and Economic Freedom”: “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.”
Banks only have to have a small percentage of physical cash to back deposits. They can create loans out of thin air, hoping that borrowers will return the loan plus interest. The loan money is created as a bigger layer on top of the physical cash. The banks hope that no more than a few percent of this money is demanded in the form of actual cash, because most of it just doesn’t exist. This is why bank runs are so damaging… they are a panic that breaks the fractional reserve system.
There are more and more layers, all of which represent paper claims dependent on the honouring of some organisation’s contract or promise.
M3b is the reconstructed version (thanks to work by John Williams of Shadow Government Statistics, and members of NowAndFutures.com) of the M3 broad money measure discontinued by the Fed on March 23, 2006. As you can see it is a key element of the inverted financial pyramid.
On top of everything is the derivatives market. Does anyone really understand them? Long Term Capital had to be rescued by a number of American and European institutions in 1998, yet it had on board Nobel-prize winning economists Myron Scholes and Robert Merton, who with Fisher Black in 1973 had developed the mathematical basis of derivatives. Warren Buffett, one of the richest persons in the world, called credit derivatives “financial weapons of mass destruction”. Well, that seems to me to be a description of something with inherent high risk. I am happy to take Mr Buffett’s word for it.
When panic ensues, people move from high risk layers to lower risk layers. Money moving out of derivatives might flow into stocks and bonds, which then gain in “value” simply by the inflow of liquidity. Then with bonds, yields move inversely with value, so bond yields and interest rates go down.
Eventually people start moving into lower layers which, counter-intuitively, appear to gain value. Now you know why debt instruments and currency have been inexplicably holding up, even as stories surface about investors wanting to dump bonds and the worst prognostications of currency bears remain unfulfilled. The risk-fleeing investors must pass through the intervening risk-reduction layers before they reach gold. In the meantime, movements in the price of gold are “just noise” (People who can’t get at their worthless funds may sell anything more liquid, including gold, to save their hides, which may result in safe-havens appearing to drop in a crisis).
The end game of course, will be when people decide they need the ultimate store of value and the asset with the lowest risk, gold. But there is little room for them in this asset class. There is just not enough of it to satisfy more than a tiny percentage of the fiat pyramid.
Smart investors have been quietly acquiring gold, at low prices, during many years in which central banks were happy to sell it off. In the eleventh hour, when everyone decides “we must have gold now”, they will rush to purchase it at any price, but it will be too late, for there will not be enough to go around to fill grasping hands.
