In 2000, Hank Paulson was the architect of changing the SEC rules regarding the leverage ratios and risk profiles of the investment banks.  Investment banks, prior to the Paulson SEC change, were only allowed to be levered $12 for every $1 of capital that they owned.  In that scenario, if a bank’s assets went down 8.3% then the bank would be technically insolvent.  Hank had the brilliant foresight to petition the SEC to allow for more self-regulation on Wall Street and allow his banks and others to lever $40 for every $1 of capital. In this scenario, a 2.5% decrease in assets wipes out the banks equity and the bank becomes insolvent.

So when you hear Paulson tell you that the reason for the problem we are in is housing, please realize he is lying to you.  He is not just mistaken.  He is lying to you. He knows better. Any investment can drop 20, 30, 40% without causing catastrophe. It is the leveraging up of these declining assets at 40 to 1 ratios that caused the problem.  Hank Paulson was the pointman in creating this leverage.  HE WUZ WRONG.

The last grade is for the bank bailouts. I give them an F. I’m a big fan of this administration, but I’ve got to be honest. The bailouts are failing. So far American taxpayers have shoveled out almost $600 billion. Yet the banks are lending less money than they did five months ago. Bank executives are still taking home princely sums, their toxic assets and non-performing loans are growing, and the banks are still cooking their books. And now the Treasury is talking about converting taxpayer dollars into bank equity, which exposes taxpayers to even greater losses.

I would say thats pretty right on.  And if a Obama cheerleader like Reich is giving you an F on the bailout then you know you are doing something very very wrong.

What does all this lead to?  Well in times of crises all of this leverage makes the downturn exponentially worse and that much harder to get out of.   But how do we deal with this issue?  Is it just a necessary evil of a modern financial system?  Last week I read a very interesting NY Times piece by Eric Zencey entitled “Mr. Soddy’s Ecological Economy.”  In the aftermath of the Depression Frederick Soddy, a British nobel prize winning chemist who helped bring about the atomic age, decided to turn his attention to economics.  He was disgusted with the destructive powers of atomic energy and turned, rather brazenly, to trying to solve the inefficiencies of economics.  He was considered a kook – he used laws of thermodynamics and nature and applied them to economics.  He had 5 natural laws that he wanted to impose (see the article for a more in depth description).  He died pretty much discredited but guess what?  Four of the five are now considered mainstream regulatory necessities.  But it is the fifth, still marginalized, that I see as a possible answer of the leverage problem of finance:

Soddy’s fifth proposal, the only one that remains outside the bounds of conventional wisdom, was to stop banks from creating money (and debt) out of nothing. Banks do this by lending out most of their depositors’ money at interest — making loans that the borrower soon puts in a demand deposit (checking) account, where it will soon be lent out again to create more debt and demand deposits, and so on, almost ad infinitum.

One way to stop this cycle, suggests Herman Daly, an ecological economist, would be to gradually institute a 100-percent reserve requirement on demand deposits. This would begin to shrink what Professor Daly calls “the enormous pyramid of debt that is precariously balanced atop the real economy, threatening to crash.”

Banks would support themselves by charging fees for safekeeping, check clearing and all the other legitimate financial services they provide. They would still make loans and still be able to lend at interest “the real money of real depositors,” in Professor Daly’s phrase, people who forgo consumption today by taking money out of their checking accounts and putting it in time deposits — CDs, passbook savings, 401(k)’s. In return, these savers receive a slightly larger claim on the real wealth of the community in the future.

In such a system, every increase in spending by borrowers would have to be matched by an act of saving or abstinence on the part of a depositor. This would re-establish a one-to-one correspondence between the real wealth of the community and the claims on that real wealth.

“People just don’t get it,” she says. “I’m attached to my BlackBerry. I was at my doctor the other day, and my doctor said to me, ‘You know, I like that when I leave the office, I leave.’ I get calls at two in the morning, when the market moves. That costs money. If they keep compensation capped, I don’t know how the deals get done. They’re taking Wall Street and throwing it in the East River.”

How did all these people make so much money?  The lack of intelligence or rationality is amazing.  Just morons.  Don’t you get it?  Your value was based on how much Wall Street made…Wall Street HAS CRASHED.  Without tax payer money none of you are getting anything.  And, believe me, the most basic job that involves manual labor is a million times tougher than yours.

Reading their crap truly embarrasses me to be a fellow American, let alone a fellow human being.  Shut the fuck up, grow up and grow a brain.  Whiny babies.

By not counting and identifying derivatives one by one and drawing a legal boundary around each by means of the rules of property law (things such as registration, traceability and standardized identification), we are unable to protect every asset and every particular interest on that asset from contamination. The longer we wait to do the math, the worse it will get. And the more likely the anarchy of this shadow economy will spread.

In the world where I come from, it is the typical state of affairs. In fact, apart from the elite Westernized minority, most people’s assets are covered by paper that is endemically toxic: not recorded, not standardized, difficult to identify, hard to locate, its real value so opaque that ordinary people cannot build trust in each other or be trusted in global markets. In short, for shadow economies outside the U.S. and Europe, “credit crunch” and “meltdown” are chronic conditions. You don’t want to go there: It will wipe out your middle class, nurturing radical politics, class confrontation, violence, crime and massive drug production and narco-trafficking. (North Americans only know drug consumption; just wait until you see the supply side of the deal.)

This is not alarmist.  This is not wacked-out man on the grassy knoll conspiracy theory.  This is real and it makes me ill.  Enough of listening to the chattering class and the media elite rationalize away the actions of the financiers who  they are in bed with.  Enough of letting these idiots telling us that the bonuses given to AIG executives is no big deal and a hyped up populist story because, well, its only 165 million and its the billions we should be worried about.  Thats supposed to make me feel better?

The elites leeched out a huge chunk of the profits over the last 25 years and now leave us with overvalued assets and a soon to be frighteningly devalued dollar.  That is not a very good combination.  And everyone just keeps sitting on their asses buying all of it.  And the few that dare to protest are marginalized as “populists” and engaging in “class warfare” (here is a fine example of that tactic).  And people just buy it:

By now, the princes of the financial world have of course been stripped naked as leaders and strategists—at least in the eyes of most Americans. But as the months have rolled by, financial elites have continued to assume that their position as the economy’s favored children is safe, despite the wreckage they have caused.

At what point do people fight back?  There is an old french saying, “Cet animal est tres mechant; quand on l’attaque, il se defend.” Translation: “What a wicked animal; when attacked, he defends himself.” Is that what we’re afraid of?  Looking bad? Angry when defending ourselves?  Is that it?

And, if you read the piece, you quickly learn that it wasn’t his software but the people who used it that screwed up so royally.  He is deeply honest about his culpability and his drive to make money without thinking of the consequences.  But he was small-fry.  So I personally take him off the hook.  Also, beyond writing about his role in the mess, he also has a fascinating take on Wall Street.  Very revealing about human nature and excess.  Here may be my favorite quote:

We had to lay off half of research. After a day of bloodletting, one of the bosses cornered me in the hallway. Did I get a sexual thrill out of firing people, he wanted to know, because it had always worked for him, big time.

For somebody who is a fairly recent transplant to NYC and has had the privilege to witness a lot of the behavior described, that quote sums up this fair city for me.  He is now an oyster farmer in Long Island, long retired, and a pretty decent guy.  Far more decent than all the assholes he worked for.

And it is full of all those cliches.  But there is something else there too.  Even the most pappy formulaic movies can be considered masterpieces if the execution is flawless (“The Godfather”).  And reading his blog you come away kind of awed at the guy’s maturity and surprisingly intelligent view of the world.  Its self-help mumbo jumbo but its finely tuned and gleaming:

You don’t have to respect someone to show them respect. I used to be under the impression that respect was to be earned. I don’t see it that way anymore. I picked up that observation here in prison. You have people inside these walls who probably cannot stand each other for one reason or another but respect is still given for the purpose of keeping order and respecting personal space and boundaries. I believe trust is something that should be earned and not given away but I can’t say that respect falls into that category anymore.

When I make observations like that I try to think back to when I was free. I ask myself, “Was respect given all of the time no matter how I felt about whomever personally?” The answer is usually, “N0.” when I go down memory lane with those people in mind (those I did not show respect to), I can vividly see where unnecessary problems took place. Fundamentally, I think that the destruction of most of my relationships came from a lack of respect on my behalf. I used to think that the whole world had to bow down and pay homage to me because of whom I was and where I came from. Crazy, huh?

Showing respect to others no matter how you feel about them personally goes a long way. Ninety-nine percent of the time people will give you the same respect you give to them. It is a natural feeling to want to be treated like a human being. Respect keeps order and order is necessary in every culture. It is my suggestion to those with attitudes like I had, prior to incarceration, make showing respect to everyone mandatory. Life is a little easier to manage that way.

You can’t really argue with any of that.

Today I read a post on Jonah Lehrer’s blog that dissects the neurological implications of boredom.  Its fascinating to read these two side by side and to see how Wallace was really onto something.  Its beyond sad that he wasn’t able to read these reports (who knows, maybe he did?) and be able to utilize it for his work.   It seems that if you attempt to describe a new reality with a new type of literature and go off your meds, well, your head breaks.