Are you ready? Begin With This List.

From Gary North....

Kicking the can has worked for years and decades.  People think short term and are linear in their views.  What will happen tomorrow will be a repeat of yesterday.

People miss the changes and really, do not want to see them.   They hide their heads in the sands and then become trapped.  People feel more comfortable not thinking about risks, or the downside, they rather think all is well and will continue to be well.  I had someone tell me, don't tell me it, I do not want to know.  "Positive" thinking is not realistic thinking.  We do need to be aware of the situation and yet, be positive to do something about it vs giving up.

Right now is the large financial restructuring that is going on, something which has not happened in the past 70 years.  It is unfolding right before our eyes.  There will be changes, and I expect some significant changes coming.  Changes that will surprise us all.

What will be the outcome?    We need to think about the risks and right now they are high and plan accordingly.

Here is an article from Gary North....

Make a List of The Most Valuable Assets You Own. Begin With This List.

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Here's How Messed Up Our Financial System Is

Motley Fool
Morgan Housel
June 15, 2009

"If I were in charge, I'd take away everything from banks that wasn't boring. Completely shut down [credit default swaps] 100%. What's the harm in this? The world worked just fine without them. We don't need an economy that resembles a vast poker tournament."
-- Charlie Munger, May 2009

Credit default swaps (CDSes) are insurance policies on various debt products -- everything from subprime mortgages to U.S. government debt. A seller agrees to compensate a buyer if debt goes into default. It's not too different from car insurance: two parties swap risk for a premium. And just like car insurance, it can be a great tool to efficiently spread risk to those who want it from those who can't handle it.

So why does Munger, Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) co-chairman, want them banned?

See, in everyday life, you can't insure things you don't own. Thankfully, your neighbor can't take out homeowners insurance on your house. If the entire town could buy insurance on one house, they'd have a huge incentive to make sure it was destroyed. They'd burn it down, blow it up, bulldoze it, what have you, pocket gobs of insurance claims for their trouble, and happily move onto the next town. For good reason, laws prohibit this.

With credit default swaps, there are no such laws. Investors can take out infinite amounts of insurance on debt products they don't own. This seriously distorts the motives and incentives between buyers and sellers. CDSes often don't act as insurance, but a tool to manipulate stupidly large amounts of money and rip gaping holes in the financial system, a la AIG (NYSE: AIG).

The Wall Street Journal recently reported an almost comical example of this. It tells the story of a tiny Texas brokerage firm called Amherst Holdings which, likely along with other CDS underwriters, took a $27 million debt security and sold $130 million of credit default protection on it. Big banks like RBS (NYSE: RBS) JPMorgan Chase (NYSE: JPM) and Bank of America (NYSE: BAC) bought these CDSes. The debt, when reviewed, was total garbage and almost certain to default, so the banks had no problem paying up for the insurance.

Now, think about this for a moment: Amherst, and likely other CDS counterparties, pocketed $130 million to insure $27 million worth of bonds. So what do you think Amherst did? Exploiting a small loophole, it used the proceeds to have the underlying bonds bought back at par, which instantly rendered the credit default swaps worthless.

It was incentivized to do this because the amount it took in from CDS proceeds substantially exceeded the bond's par value, so it could burn millions of dollars buying out the bonds and still make a tidy profit. By making the bonds whole, there was zero chance of default, so Amherst's insurance obligation disappeared.

Of course, there really was no insurance involved. There wasn't even an investment. As Munger notes in the opening quote, it's simply a vast, unregulated game of poker. Spun the other way, CDS buyers have an incentive to make sure underlying debt defaults. They can achieve this by buying CDSes for multiple times a company's debt load and causing a run on its assets. Indeed, this is exactly what many believe ultimately pushed Lehman Brothers into bankruptcy.

In the utopic minds of those who created them, credit default swaps prevent meltdowns and mitigate risk. In reality, scarcely anything in our economy possesses a greater risk of bringing down the house. Thanks to the ability to insure debt for multiple times its value, the notional size of the CDS market is more than $38 trillion, or nearly three times U.S. GDP. That's $126,000 for every man, woman, and child in America. This is quite literally a poker game multiple times the size of the entire economy.

Yet we've still done very little to fix it. CDSes are still sold, bought, and traded in staggeringly large sums based on rules dictated by those who created them. As Goldman Sachs' (NYSE: GS) annual report states, "The market for credit default swaps is relatively new, although very large, and it has proven to be extremely volatile and currently lacks a high degree of structure or transparency." Whoo-hoo!

Read that quote again, remind yourself what got us here in the first place, pound your head on the table, and ask yourself why we hold frequent congressional hearings to quibble over things like executive pay, but sweep issues like credit default swaps under the table and hope they fix themselves.

Banks or Hedge Funds

A Story within the Story
Following the collapse of the biggest credit bubble in history, there has
been no shortage of finger pointing and the hedge fund industry, which has
always had an uncanny ability to be at the wrong place at the wrong time,
has yet again been at the centre of attention. And politicians, keen to divert
attention away from themselves as the true culprits of the crisis through
years of regulatory neglect, have been quick at picking up the baton.
Admittedly, the hedge fund industry is guilty of many stupid things over
the years, but blaming it for the credit crisis is beyond pathetic and the
suggestion that increased regulation of the hedge fund industry is going to
prevent future crises is outrageously naïve.

If you prohibit private investors from investing in hedge funds which on
average use 1.5-2 times leverage but permit the same investors to invest in
banks which use 25 times leverage and which are for all intents and
purposes bankrupt, then you either don’t understand the world of finance
or you don’t want to understand. Shame on those who fall for cheap tactics

Bank of England warns tensions in banking system at fever pitch

Tensions in the financial system are approaching the fever pitch they reached before the collapse of Lehman Brothers last October, the Bank of England has warned.