Enter the Credibility Trap: A Prediction About the S&P Ratings Lawsuit

No, I do not predict that there will be no criminal indictments and convictions to follow the suit, or even serious personal penalties from the civil action beyond something that is tax deductible as a cost of doing business. That is like predicting that a heavy rain will make puddles.

I predict that the primary defense that will be offered by S&P will be based on 'the credibility trap' itself.

The usual defense in cases like this is the First Amendment, that S&P was merely voicing an opinion. In this particular case, after having combed through over 20 million documents, the Department of Justice will attempt to prove that S&P was not merely voicing an opinion, but lying for gain, which is not 'protected speech.'

And most of them obviously cannot use the CEO defense of non-involvement and general ignorance of the entire situation, since they were being paid to write professionally informed judgements based on a factual due diligence.  It would be like a surgeon arguing against malpractice because he was watching porn while performing surgery, and was so distracted he did not really notice what he was doing and was therefore merely a hapless bystander.  Don't laugh.  It seems to be working for MF Global, and several national governments.

Having these usual avenues thwarted, I suggest that S&P will point to all the other credible voices of the economists and politicians, 'very serious people,' who said either absolutely nothing, or voiced similarly misplaced opinions and 'mistakes in judgement' about the true nature of the unfolding financial frauds.  How can you blame us, when no one of consequence said anything differently, forcefully.

So rather than key actors in a massive control fraud, they will portray themselves as hapless victims of the same mass delusion that affected most of the New York-London-Washington establishment, with many top universities in their supporting cast. 

Will Alan Greenspan offer to be an expert witness on the perils of mistakes made while blinded by a sincerely held ideological delusion?  Poor fellow, just a good chap making an honest error in judgement.  He used a bad model.  Who can blame him.

The defense will be 'the credibility trap' itself.  You cannot convict us, without indicting yourself.  

And if they are as I think they are, the S&P team will bring some credible implications of their case for the sacrosanct TBTF crowd to the plea bargaining process, and make its objective the best terms in a settlement while admitting no wrongdoing.   We chose to settle because it was cheaper.  We are victims of big government.   The usual suspects will run with that.

It is a corollary to the credibility trap that no one who knows 'where the bodies are buried' will be personally inconvenienced beyond mere appearances.

It will be interesting to see how this plays out.  It might set the tone for the 'investigations' of the coming collapse and scandal in the paper silver market.   How could we have done anything wrong when the CFTC investigated us for five years, and sat next to our people almost every day?

What Time Is the Next Crisis? - An Historic Warning From John Hussman

"The enemy of the conventional wisdom is not ideas but the march of events."

John Kenneth Galbraith

This is from John Hussman's latest weekly observations which you can read here.

In every instance he cites with which I am familiar, any concerns about the gross mispricing of risk were lightly dismissed, because 'the market says that everything is all right.'   As if the financial markets were some prescient, infallible instrument, and not overtaken by the manipulation of insiders and the monied interests. 

The 'rising market' kept most criticism of the policy errors in the growth of the credit bubble cowed and quiet, until the inevitable market break and crisis. That the financiers have not yet completely destroyed the global economy is not particularly reassuring, while they are still working at inscribing their arrogance, writ large on the pages of history, chapter by dreadful chapter.

Or more cynically one can conclude that yes, things are getting out of control, but we must keep dancing while the music is playing, and say nothing while the money is flowing in order to 'save the system,' while disabling the smoke alarms and stuffing one's pockets.

As long as the Fed can keep printing money and delivering it to the Banks and the one percent, and not to the real economy, through its purchases of their (fraudulently) mispriced financial assets, this could keep going, while maximizing the damage.  While it does give the financial engineers some feeling of control, it really does nothing constructive except to delay the essential reforms.

The combination of constructively applied stimulus and sweeping financial reform was the genius of Roosevelt, and the lack of it is the failure of Obama.

And the big correction might not even show up all that readily, in nominal terms at least, in the equity markets for some time, being papered over by a blizzard of new money.  And so that implies a crash in the bond markets, as we saw a few years after the Great Crash of 1929.  But they are getting better at the cover ups, so who can say.

The tail of financialization and leverage is still 'wagging the dog' of the real economy.   After reading the current thoughts in mainstream economics, and Modern Monetary Theory, it seems quite likely that history is about to deal out another hard lesson in real wealth and value.

I am ambivalent to the exact timing since I cannot know it.    And so if another year passes and 'nothing happens' I may not be cheered by it while the fundamentals like median wage continue to deteriorate.  This is the mechanism in which bubbles develop, and we have seen more of them than most, and with increasingly intensity.

But I am more confident that the punchline to this comedy, if it continues unabated, will be the devaluation of the currency and at least a de facto default on the debt which can take several forms. And the usual yahoos will rise up and seek power, promising an hysterical people to take away their pain, while inflicting it on 'the others.'

"Present market conditions now match 6 other instances in history: August 1929 (followed by the 85% market decline of the Great Depression), November 1972 (followed by a market plunge in excess of 50%), August 1987 (followed by a market crash in excess of 30%), March 2000 (followed by a market plunge in excess of 50%), May 2007 (followed by a market plunge in excess of 50%), and January 2011 (followed by a market decline limited to just under 20% as a result of central bank intervention). These conditions represent a syndrome of overvalued, overbought, overbullish, rising yield conditions that has emerged near the most significant market peaks – and preceded the most severe market declines – in history:

1. S&P 500 Index overvalued, with the Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) greater than 18. The present multiple is actually 22.6.
2. S&P 500 Index overbought, with the index more than 7% above its 52-week smoothing, at least 50% above its 4-year low, and within 3% of its upper Bollinger bands (2 standard deviations above the 20-period moving average) at daily, weekly, and monthly resolutions. Presently, the S&P 500 is either at or slightly through each of those bands.
3. Investor sentiment overbullish (Investors Intelligence), with the 2-week average of advisory bulls greater than 52% and bearishness below 28%. The most recent weekly figures were 54.3% vs. 22.3%. The sentiment figures we use for 1929 are imputed using the extent and volatility of prior market movements, which explains a significant amount of variation in investor sentiment over time.
4. Yields rising, with the 10-year Treasury yield higher than 6 months earlier.

The blue bars in the chart below identify historical points since 1970 corresponding to these conditions.

MIchael Lewis and the Heart of the US Economic Policy Failure and Crisis

"Corruption is a tree, whose branches are
of an immeasurable length: they spread
Everywhere; and the dew that drops from thence
Hath infected some chairs and stools of authority."

Beaumont and Fletcher, The Honest Man's Fortune

Michael Lewis has written an excellent pocket analysis of the financial crisis in The New Republic, in his review of Greg Smith's book about why he left Goldman Sachs.  I have to admit some prejudice, because he says all of the things which I have been saying, and says them very well.

Crony capitalism has always been with us, but it took wing in the 1990's, and has brought us to this place where we would not wish to be.

Michael Lewis does an excellent job of distilling the problem and its solution to the basics, without necessarily touching on the need to reform the political campaign process, and the revolving door that enriches the politicians and regulators through betraying the spirit, if not the technical word, of their oaths of office.

Is a policy error still an 'error' if it is done purposefully? 

I had hoped that Obama might have risen above that as an 'outsider' with a mandate for change, but that notion was quickly dispelled in his first 100 days in office.  He has pursued a policy of subsidy and appeasement and failed leadership that is killing the legacy and effectiveness of his administration, but enriching many participants in the process. And it works, because the US has become a culture of personal greed. 

One can speculate on motives endlessly, but we'll leave that one to history.  The end result remains the same.  And the pity is that the 'opposition party' is even worse, even more servile to special interests.

And the oddest thing is that this is almost a general phenomenon throughout the developed world, and not some anomaly of the US. And the culture of greed and economic repression was spread by highly placed political appointments affiliated in many cases with the same handful of US-UK banks.

In the aftermath of the first Great Depression there was a general spread of militant fascism, and a great world war.  So why not a rise of oligarchies employing financial repression this time, with a global currency war?  There appears to be some precedent of corruptible, power mad people rising to the occasion.

The Western governments have come to resemble competing crime families, more than an open democratic process of policy formulation for the good of the entire nation through constructive give and take.  It's mostly take, with the common people being taken, while the media and the pundits weave an alternative reality for them with words and emotion.

So, here we are.

What do you want to do tonight, Marty?

"Stop and think once more about what has just happened on Wall Street: its most admired firm conspired to flood the financial system with worthless securities, then set itself up to profit from betting against those very same securities, and in the bargain helped to precipitate a world historic financial crisis that cost millions of people their jobs and convulsed our political system.

In other places, or at other times, the firm would be put out of business, and its leaders shamed and jailed and strung from lampposts. (I am not advocating the latter.) Instead Goldman Sachs, like the other too-big-to-fail firms, has been handed tens of billions in government subsidies, on the theory that we cannot live without them. They were then permitted to pay politicians to prevent laws being passed to change their business, and bribe public officials (with the implicit promise of future employment) to neuter the laws that were passed—so that they might continue to behave in more or less the same way that brought ruin on us all.

And after all this has been done, a Goldman Sachs employee steps forward to say that the people at the top of his former firm need to see the error of their ways, and become more decent, socially responsible human beings. Right. How exactly is that going to happen?

If Goldman Sachs is going to change, it will be only if change is imposed upon it from the outside—either by the market's decision that it is no longer viable in its current form or by the government's decision that we can no longer afford it. There is a bizarre but lingering aroma in the air that the government is now seeking to prevent the free market from working its magic in the financial sector-another reason that the Dodd-Frank legislation is still being watered down, and argued over, and failing to meet its self-imposed deadlines for implementation.

But the financial sector is already so gummed up by government subsidies that market forces no longer operate within it. Could Goldman Sachs fail, even if it tried? If someone invented a cheaper way to finance productive enterprise, would they stand a chance against the big guys?

Along with the other too-big-to-fail firms, Goldman needs to be busted up into smaller pieces. The ultimate goal should be to create institutions so dull and easy to understand that, when a young man who works for one of them walks into a publisher's office and offers to write up his experiences, the publisher looks at him blankly and asks, 'Why would anyone want to read that?'"

Michael Lewis, The Trouble With Wall Street

Gold Daily and Silver Weekly Charts

There was some top calling after the big run up last week, especially given the ebullient cover of Barron's over the weekend.

Let's see if we get a trend break before the bears come out of the woods to pile on.

The capping on gold and silver is determined. When they break free, then we will see this market wiggle out of the grip of the pigmen, who are using it as their personal ATM.