More ridiculous than before.

If you think that $750 billion was a ridiculous subsidy to the TBTFs, or that they really didn't join with the government to steal from the public during 2008, the epilogue over the next three years went from ridiculous to stupefying. From 2008 – 2010 we ran about $1,100 billion per year in additional deficits over the Bush years, for a total of $3.3 trillion. This too was sold as “for the people” but that was a lie. See, financial product credit (Z1 line Z1/Z1/LA794104005.Q) contracted from $17.1 trillion to $13.8 trillion today, or almost exactly the same $3.3 trillion. Mortgages, during the same period, would contract by about $600 billion while non-financial business credit remained pretty-much flat and State and local borrowing expanded. Put another way, the entire deficit addition over the previous multi-year baseline was literally given to the financial firms; the total amount of the taxpayer heist is over $3 trillion from 2008-2010, and as of the 2nd Quarter of 2011 we're still literally stealing from the taxpayer and handing it to the TBTF institutions via government deficit spending.

To understand this you need to noodle for a few minutes; put yourself in noodle-mode and grab a coffee. You'll have to roll this around in your head before it gels, but it will.

Let's start with a couple of fundamental facts:
We have a “fiat” currency – the dollar. All “dollars” are in fact debt instruments. Pull out one from your wallet (pick a denomination, so long as it's not an old silver certificate!) and you will see “This note is legal tender for all debts, public and private” printed on the face. The language is precise and important: I may demand payment for my gasoline in oranges and you must pay in oranges provided I never allow you to go into debt to me for the gasoline. As soon as I do (e.g. by letting you pump it before you pay me) I must accept dollars.

All dollars are debt-backed. Specifically, they're issued against an obligation, typically against Treasury debt. When the Federal Reserve wishes to emit more “dollars” (whether electronically or otherwise) they buy Treasuries and pay for them by either printing dollars or pushing a button and creating digital facsimiles of paper notes.

This, incidentally, is why when you read Leverage (and you should) you'll understand how and why the “money men” at the banks robbed everyone through what is effectively a naked short on the currency. But that's not the point of this post.

Rather, the fact that there's a liability associated to the asset in the form of dollars means that the entire economic system is a gigantic balance sheet.

And the fundamental truth about balance sheets is that they balance.

So if you want to get rid of excessive debt you must also write off assets. The asset side of the balance sheet has to contract at the same time the liability side does. There's no escaping this fact. It is simply not possible to contract one side without the other, because by definition a balance sheet must balance and when you “blew up” one side you also “blew up” the other.

This fact, however, means that if someone is over-valuing assets then someone is also claiming a liability they cannot pay. Again, the two are exactly in balance – always. So when the bank is holding home equity lines at 100 cents on the dollar (“par”) when in fact the loan is a second lien behind an underwater first mortgage that is delinquent, not only is the bank lying but the homeowner is lying too – he has possession of something he hasn't and can't pay for.

So what happens when the bank is forced to recognize this bad debt? It has to write it down; the asset disappears at the same time the liability does. But if the lending institution can't cover the write-down because it has insufficient capital to do so it blows up.

Now you should understand why delinquent homeowners are, in many cases, living in houses without making a payment for two years. The banks aren't “overwhelmed”, they're bankrupt. They're not kicking people out because if they do under the accounting rules they have to recognize the loss and doing so causes their demise! They're not doing the delinquent homeowner a favor, they're doing themselves a favor while committing (legal) balance sheet fraud.

The fact that balance sheets must balance becomes extremely useful when looking at the macro economic picture. If the government is deficit spending the additional debt goes on their balance sheet. The question is where is the flow go on the other side? If the entire credit picture is expanding across the economy compared to output (GDP) then the answer is that we're simply blowing bubbles. That's what happened in aggregate over the last 30 years.

But right now the credit picture isn't expanding much. Government borrowing, however, is!

Someone is contracting credit at the same time the government is expanding it. That is, while the total system liability is not changing much liability is shifting from a private party to the taxpayer. Let's figure out who's getting the benefit.

Remember, the “narrative” run by the media and the government is that they're “helping the people.” If that was true then we would see that $3.3 trillion show up in the form of decreased debt held by people. But that hasn't happened – the aggregate “all instrument” Household and Non-profit credit peaked at $13.9 trillion and today is just $600 billion smaller, nearly all in mortgages.

The Fed Z1 tells us how the composition of liabilities is shifting over time and what the general picture of those liabilities “in aggregate” are. It is one of the most-useful tools for this sort of macro-level analysis, because it is basically impossible to successfully corrupt. It's also one that most people don't look at; it's not “in your face” and announced in the mainstream media like GDP or employment data is, and there's no “headline” number to focus on. Instead it's just a jumble of figures. Fortunately, Excel is really good at taking columns of numbers and turning them into pretty pictures, like this:

And what that Z1 is telling us, today, is that from 2008 to now about $3.3 trillion in credit was removed from the Z1 line called “Financial Products.”

When we look at the household sector we find that it's not mortgages where that help went (those are separately accounted for); in point of fact that number has only gone down by about $600 billion.

Here's the rub: Home values, according to Zillow and Case-Schiller, have contracted by something between $6-10 trillion. How is it that only 10% of that value change has shown up in the outstanding debt when just 30% of homes are owned free and clear and a quarter of all homes are underwater on their mortgage? Remember, all second lines behind an underwater first are worth zero if the first goes 60+ delinquent, as the odds of cure on a 60+ mortgage is statistically indistinguishable from zero and a second only recovers on a foreclosure after the first is paid in full.

The answer to that is simple: Institutions are pretending that some debt instruments have value when they really do not. That's the only possible explanation since again, balance sheets must balance.

But in the case of financial credit it really has been contracting on a recognized basis. This would normally be enough to blow all of these institutions to beyond the orbit of Mars; note that the common “TBTF” banks are somewhere around $500 billion to ~$1 trillion in size. The contraction of $3.3 trillion in financial products credit, given their leverage, would be enough to bury them all.

That hasn't happened.

The reason it hasn't happened is that in effect the credit they were carrying — remember that “liabilities” on one side are “assets” on the other — was effectively transferred to the Federal Government via additional deficit spending.

The amount of “back door” bailing out through transference of the banks' (bad) “assets” to the federal government, relieving them of what would otherwise have blown them to bits, amounts to approximately $10,000 for every man, woman and child, all taken on over the last three years. And note that this not total deficit spending, it's only additional deficit spending over what Bush was running before (if you look at the total it's even worse — in excess of $4.5 trillion.)

This is what the media means when they say “the private economy is de-leveraging” — they're only really speaking about the “1%”, in this case the TBTF institutions.

The statement on balance is false when applied to the entire economy: You may think you're de-leveraging but the economy as a whole is not; instead you're having the private obligations of a small number of people, in this case the TBTF banks, forced upon you as taxpayers as the government levers up to counteract private credit contraction among the big multi-national and national banks!

In short every citizen of this nation — man, woman and child — has been robbed of $10,000 which was taken from you and given to the TBTF banks to prevent them from blowing up, with the obligation to pay in the future shoved in your face at literal gunpoint by the government.

So much for “de-leveraging” of the private economy, at least as it applies to the 99% of the nation!

The government didn't “expropriate” or “extort” anything from the TBTF banks as is commonly said by the right-wing side of the aisle — in fact government actively conspired with the TBTF to steal your money and give it to those very-same institutions while it was lying about helping you.

The Fed Z1 – a simple compendium of mathematical facts – does not lie.

Denninger again. *

October 22, 2011 tc Uncategorized