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Recessions, derivatives, manipulations and depressions What is happening?

By Christopher Davis
There’s a theory or you might call it an operating principal that if risk is spread thin enough it will disappear. This is like the water treatment business which I have experience in.
In that business if you have contaminated water, the least expensive method to bring it under control, meaning below maximum contamination requirements, is to mix it with an inexpensive source of clean water. This technique is generally a good fix at least in the short term, that is if you have a steady enough supply of new clean water to mix it with.
In finance, they apply the same principal. They try to spread the risk as thinly as possible.  This often brings about new financial instruments being fabricated into existence. These instruments are generally referred to as derivatives.
If you group together a bunch of sub-prime mortgages into a package it’s not going to be an attractive enough package to sell, but if you dilute the contaminated mortgages with some good ones then the dilution could be good enough to package and sell. Voila, a sellable package.
We are all familiar with the sub-prime mortgage crisis of 2008. That is a crisis that began with dilution of risk but got out of control. There weren’t enough good mortgages being mixed into the continually increasing flow of toxic mortgages.
Derivatives didn’t stop in 2008, it just changed form. The toxic instrument dilution process continues unabated in the financial community in different forms because of the demand for low-risk or risk-free debt instruments which are called for by pension funds and institutional investors.
Yet as an economic expansion progresses, especially one that has been extended and distorted with the Fed’s cheap credit, these derivative financial securities are being polluted with more and more toxic waste.  Spreading the risk ultimately pollutes the entire pool of liquidity.
The toxic pool increases as businesses fail to keep up with the needed expansion rate demanded by additional debt on terms of loan services, increased taxation and a diminishing market. This is the scene today.
Continually attempting to spread the risk ultimately pollutes the entire pool of liquidity. The pool become less attractive and the demand drops. This happens regardless of the Fed pushing more and more inflation dollars into the system. In fact, it happens more because of the losses incurred in inflated return values.
Today it’s no longer subprime mortgage backed securities, it’s what they call Collateralized Loan Obligations (CLOs).
CLOs invest mainly in leveraged loans, i.e. bank loans to firms that are highly indebted, have high debt service costs relative to earnings and are typically rated below investment grade. So, they put a bunch of these together, “spreading the risk” and maybe sprinkle in a few good performers, and doing so they create a new derivative they can package and sell.
These are collateralized loans, just like mortgage loans are. They’re collateralized loans because the firms borrowing the money are risky.
The leveraged loan market has surged in recent years to roughly $1.4 trillion, most of which exist in the US.
The rapid growth of these CLOs is terrifyingly like what happened in the subprime mortgage market.
Why is this frightening? Isn’t the economy strong?
The stock market, which is not actually a prime indicator of economic health, is being supported by tax breaks, corporate stock buybacks and the Fed’s influx of new money into the market. This is what is buoying up the stock market. The stocks are just about uniformly overpriced, way beyond what would be considered as viable price earnings ratios. Stock, like the currency is inflated, in fact the hidden inflation can be seen in the high stock valuations. It takes a long while for the effects of inflation to hit main street.
One of the prime indicators of banking health is what is called the REPRO market. This has been in the news lately, but it’s not new. The REPRO market is the overnight lending rate that the Fed provides to the banks.
At the end of each day the banks must balance their books, and if they are short they pledge collateral to borrow from the Fed so as to buoy up their books. The next day they pay off the loan and buy back the collateral. That’s why it’s called the REPO market. In the past, this has been there for occasional needs, but of late the banks are continually borrowing from the Fed daily. It’s like they are barely treading water. It appears their arrears are building up and that’s why an increasing REPO pool is necessary.
Translated that means that if that large pool of freely available loans were not available, the banks would likely need to immediately declare bankruptcy.
The size of the fed pool necessary to handle this is enormous. Much of the new currency has gone to this pool which is higher than it has ever been in the history of the world.
In today’s market the problems in the repo market could be a warning that the CLOs are turning to toxic waste, and, thus, are developing into the next financial crisis. But this time a market crash in one sector such as the CLOs will precipitate a domino effect that it is unlikely the Fed can handle.
Some say that a recession is already here, but you’re not going to hear that from any politicians. The Fed trees to keep the inflation rate at about 2 or 3 percent in order to keep us out of a recession, but has been unable to do that. Right now, for October it was listed at 1.7%. That is 1.7% above the deflation line. But whether it is recession or not, a full-blown one is around the corner somewhere.
The above is just one indicator that we need some fundamental changes to our economy.
Cryptocurrencies have arisen, but in my opinion they are not viable option.
For those who are interested in what I see as the next BIG thing I suggest you learn about CloudCoin the new cloud based digital currency. It’s time for a change, and this could be it.



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