Guest Post: The Next Wave of the Financial Crisis is Coming (And Why)

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Served by Jesse of Le Café Américain

These excerpts from the most recent TARP Congressional Oversight Panel Report make the risks in the US financial system abundantly clear.

Do you think that the Congress has the will and the ability to act on their recommendation, with the men currently in positions of power on the key Committees? Do you believe that the Obama Administration is capable of reforming itself and effecting genuine change with so many Wall Street denizens forming their policy?

“In order to advance a full recovery in the economy, there must be greater transparency, accountability, and clarity, from both the government and banks, about the scope of the troubled asset problem.”

We are persuaded that the government is waiting for the next wave of failures, or some exogenous event of catastrophic proportion, to provide their rationale to take new aggressive action.

But while the financial oligarchy is in control of the men in power, we doubt that these will be the right steps for the majority of Americans, the US economy, and its debt holders.

“There are a thousand hacking at the branches of evil to the one who is striking at the root.”
Henry David Thoreau

Congressional Oversight Panel – August 11 Report – The Continued Risk of Troubled Assets

“…But, it is likely that an overwhelming portion of the troubled assets from last October remain on bank balance sheets today.

If the troubled assets held by banks prove to be worth less than their balance sheets currently indicate, the banks may be required to raise more capital. If the losses are severe enough, some financial institutions may be forced to cease operations. This means that the future performance of the economy and the performance of the underlying loans, as well as the method of valuation of the assets, are critical to the continued operation of the banks.

…If the economy worsens, especially if unemployment remains elevated or if the commercial real estate market collapses, then defaults will rise and the troubled assets will continue to deteriorate in value. Banks will incur further losses on their troubled assets. The financial system will remain vulnerable to the crisis conditions that TARP was meant to fix.

…Part of the financial crisis was triggered by uncertainty about the value of banks’ loan and securities portfolios. Changing accounting standards helped the banks temporarily by allowing them greater leeway in describing their assets, but it did not change the underlying problem. In order to advance a full recovery in the economy, there must be greater transparency, accountability, and clarity, from both the government and banks, about the scope of the troubled asset problem. Treasury and relevant government agencies should work together to move financial institutions toward sufficient disclosure of the terms and volume of troubled assets on institutions‟ books so that markets can function more effectively. Finally, as noted above, Treasury must keep in mind the particular challenges facing small banks.

This crisis was years in the making, and it won‟t be resolved overnight. But we are now ten months into TARP, and troubled assets remain a substantial danger to the
financial system

…Nonetheless, financial stability remains at risk if the underlying problem of troubled assets remains unresolved.”

The banks must be restrained, and the financial system reformed, and the economy brought back into balance, before there can be any sustained recovery.

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  1. Anonymous


    There is no chance that these festering and growing problems will be solved in the current context.

    As Senator Dick Durbin said "they own the place". The financial and political oligarchy will try and squeeze blood from the taxpayer stone. Let there be no doubt about that. Ultimately the math will win – by next year the government debt will be around $15 trillion and annual interest payments on that debt will be around $500-$700 billion. This can only continue to escalate so far when it becomes untenable. No different than how the most recent "mortgage finance" credit bubble burst.

    What happens when the average working stiff realizes he has been shorn of everything and his childrens future? If history is any guide then we should expect demagogues that will incite us vs them and divide the population to control them. They will find scapegoats in some of the weakest groups – lynch mobs will take out their frustrations on these groups. Spontaneous or willfully orchestrated?? While the kleptocracy abscond with their ill gotten gains and maintain political power with an iron fist. This is how brown shirts and goose steps come into being.

    We are inexorably moving towards the dark side of human nature and history.

  2. Anonymous

    if you can afford to quit and job and living off savings you might as well enjoy it before massive inflation sets in and ruins it anyway. I am all for starving the beast of whatever tax dollars i can. At this rate I wouldnt be beyond walking away from my home eating the lost equity and downsizing substantially. Blood suckers are parasites. We are still supplying the blood. Thats on us.

  3. Anonymous

    Emotions and fear – the main thing that made most of the people outsiders…, I believe that there will not be any "second wave". Many people sitting on the "upside" doesn't want it, cause they will also suffer! So without any serious reason most will not "short" the market…

  4. Anonymous

    Jesse? What do you suggest happens to rein in debt…..extend it out to future generations and let the government run the marketplace…..oh wait…

    Locally statewide nationally vote them all out.

  5. Hugh

    This is repeating what many of us have been saying. The fundamental problems have been left unaddressed. The banks are insolvent as ever because all the crap on their balance sheets is still there. If anything their condition has worsened because the value of those assets continues to decline. Yet the dominant philosophy remains that of the "Emperor's New Clothes". The financial system is bankrupt but if we all pretend that it isn't . . .

    I agree too that it is all about the math, and the math remains strongly negative. At some point, the government will have to pull back from its unsustainable support of the old system of crony casino capitalism, and then we will be back where we started facing depression but with fewer resources to fight it. I come back to the point that the political leadership in this country of both parties is completely incapable of understanding the problem or doing anything effective about it.

    Now you might ask how I can be so sure that nothing will be done. To this I would say that we are now 2 years out from the collapse of the housing bubble and 11 months out from the financial meltdown. I would not expect to see all of our problems fixed in these lengths of time, but for none of the underlying problems to have been even addressed or a solution started? It is this misdirection of resources and lack of action on the real problems: unemployment, debt, regulatory reform, housing, commercial real estate, pension funds that means come 2011 if not before things could get very nasty indeed.

  6. Anonymous

    An increasing number of people have identified the current stock price salient as a new bubble. The Third Bubble, it would be… and inflated knowingly and deliberately by the Fed, whose view of the economy appears myopic and limited.

  7. Anon1

    President Kennedy had come to the reasoned conclusion that Vietnam was a debacle in the making. A lost cause. He was going to start bringing the troops home…but then he was assassinated.

    LBJ took over and he knew precisely the same thing Kennedy knew, but he didn't do anything to fix the problem (no winding down the US role in the conflict) instead, he ratcheted it up. He simply decided that he could not be the first President to "lose a war" so, rather than doing what even he recognized was the right thing, he stepped on the gas in hopes of avoiding being THE guy in charge when we lost a war.

    That same stupid trap, that same stupid thinking, applies to the current financial situation. I cannot imagine that many of our "leaders" don't actually see the problem and KNOW what the correct response is, but they refuse to be the one holding the bag when pain is affirmatively applied to the American people. Instead, they are trying to prop up the lost cause in hopes that it will be the NEXT guy holding the bag when the feces hits the oscillating blade.

  8. Anonymous

    Many are aware of the outstanding problems….but their numbers are inconsequential compared to the vast American idol public mass.

    So we diverge, a few expecting the other shoe to drop and positioning themselves accordingly, while the majority believe the media spew (well sorta, not enough evidently to take on even more debt).

    Time will tell how things turn out.

    Note though that the the US Government appears same as always… despite Obama saying it would be different.

    Plan accordingly.

  9. dd

    Recreating financial systems is what Americans do best. We have no regard for money and re-invent it at will. The Jefferson-Hamilton-Jacksonian debate continues on. What Americans understand is that money is at best a matter of faith and at worst no better than an itinerant preacher. It is what we believe no matter its guise be it gold or fiat.
    I have great faith that we will move forward again after yet another revolution in the many we have had since 1776. Americans love money but we are not wedded to any particular kind; just the one that functions in the moment.

  10. Nahtanoj

    Sure, there are still lots of bad assets on bank balance sheets, and many of them haven't been marked to market yet. And that could lead to crisis in the future — either for individual institutions or the financial system as a whole.

    But a big part of the strategy seems to be for the banks to earn their way out of the hole over a period of at least several years. They now have an EXTREMELY low cost of funds, thanks to FDIC guarantees of their debt and an environment of low policy rates set by the Fed. So they should be able to make (lots of) money on their non-defaulting assets. Eventually, this brings their balance sheets back to health.

    This approach was a core element of the financial recovery policies of 1990 – 1994 (low policy rates permitted the banks to earn their way out of a hole), and it seems to be a core element of today's strategy, as well. Who's to say it won't work?

  11. Jesse

    "Who's to say it won't work?"


    In all this excitement, I can't remember if we have blown three bubbles or four. But seeing as how this is the US economy, the largest in the world, and will blew itself clean off the face of the planet if we keep this up, do you think we should go for one more bubble?

    Are you feeling lucky? Well, are you?

    Apparently so.


  12. Hugh

    The question too is on whose back are banks going to earn their way back to solvency? We are talking about consumers, mortgagees, etc. And can these groups really afford to pay in fees and charges what it will take to recapitalize the banks, given their own precarious finances?

  13. Anonymous

    I'm pretty positive about the 2nd Revolution coming. The Alt-A and Option ARMs won't really start hitting until Fall of 2010. The Commercial Real Estate market is toast, they are predicting more than 50% defaults about $660 billion. Most of the houses that have been bought this year about 70% of them are from 1st time home buyers who took advantage of the $8K tax credit, even those homes will end up being upside down as the housing bubble continues to deflate. Prime mortgage home owners will walk away from their homes once they realize that they owe tens of thousands of dollars more than the property is worth. People buried in credit card debt will default when their interests rates rise to 15, 25 even 30% in order to pay for all those newly unemployed that have to default on their credit card debt. No matter how you look at it, the American consumer has to unload 20 years of bad debt caused by irresponsible lending practices. Years of fraud where government, banks and corporations have painted a picture of American prosperity by financializing the American economy in order to hide the fact that wages have not really increased for the average American since the 1970's is now going to bite everyone in the ass. But we have no debtors prisons and the elite have behaved very very badly to the point that they cannot hide the fact. Americans default, walk away, save money and prepare for government to do it's worst, because they are going to.

  14. eh

    "Yesterday's news" the markets seem to be saying. I've often wondered myself, and asked on blogs similar to this one: What happened to those "toxic assets"? It wasn't that long ago that you heard a lot of talk about the PPP — how to deal with them. No more. Nada. Looking at the news flow it is hard to believe they have become less "toxic".

    Tape and momentum traders who are good at it must love this market. People who rely on fundamentals and related underlying factors, not so much. Hard to know what to do.

  15. Jessica

    How does the Obama healthcare plan factor into all this? Is it really worth all the money and effort that is being invested into it?

  16. fresno dan

    Japan = US

    BTW "Jesse" – love the reference to Dirty Hairy….hmmmm….kinda like our financial situation – dirty, hairy. But you forgot "punk"

  17. Anonymous


    I enjoy many of your posts, and appreciate your blog.

    I have to mention that your GTU/CEF/GLD/SLV updates are interesting, but that you seem to have overlooked that GLD/SLV do not trade at anything close to the discounts you suggest. In fact, they do track the bullion price and the NAV very closely. The missing piece is that they do not represent 1/10 of an ounce. They did at inception of the funds, but fund expenses have since reduced that fraction on a regular basis. That's how the fund expenses are paid. See
    As of today, the shares represent approx 2% less than 1/10 of an ounce (0.098138 vs. 0.1 oz.), which at 0.4% expenses per year implies that the fund has been operating approx 5 years.

    Yves, please pass along to Jesse as I'm sure he'd like his frequent posts on this topic to be accurate.

    Jesse, again I appreciate your writings. Please add a comment section to your blog so we can give feedback.

  18. Anonymous


    Me again. BTW, on your blog you point out something interesting that I haven't seen elsewhere–the distinction between "claim" and "putative claim" for CEF/GTU. Is there a link that discusses the difference in structure of CEF/GTU?



  19. Anonymous

    It is too late for the government to seize the banks and convert the banks' debt to equity. The government now guarantees bank debt. The only way out is for the government to inflate – hold the fed funds rate at zero until the banks recoup their losses. The question is will they contain this inflation at 5-10% or will it spiral out of control?

  20. Siggy

    In the coming three quarters I expect to see banks using retained earnings to absorb the worthless paper they are still carrying on their balance sheets. I also expect unemployment to continue to expand.

    It took 50 years to get to this juncture and the problem exists in both the arithmetic of finance and the mind set of individuals and the market. This crisis is all about the excess reliance upon credit, an abrogation of personal responsibility, and a complete failure of political institutions.

  21. Bleichroeder

    the resolution of the S&L crisis offers some insight to the serious mistakes being revisited by the current intervention and their eventual cost.

    merging troubled banks, allowing insolvent financial institutions to be propped up, and allowing lenders to keep essentially worthless assets on the balance sheet at inflated cost significantly delayed the eventual resolution of the underlying issues. in the context of explicit government support and artificially cheap access to capital, the government has handed banks already facing strong incentives to take risks to restore profitability the loaded pistol with which to play russian credit roulette.

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